Sunday, October 23, 2011

Ilargi: The term "Receding Horizons" (just when you think you can touch the pot of gold, it's moved out of reach again) I first defined years ago with regards to energy is back, this time in - crisis - politics. Just as Europe would need to show a more united front than ever, the gloves are coming off. And there's nothing but solid logic behind it all: the deeper the crisis, the more the various needs diverge.

President Sarkozy faces a 2012 election campaign with a sovereign credit rating downgrade looming ever bigger. And French banks in devastatingly deep doodoo. Chancellor Merkel, however, faces entirely different priorities: strong opposition from all sides, including her own party, to ever growing German funds and credit being used to prop up the sinking parts of Europe.

When a crisis is still in its shallow phases, it's easy to make believe that it's best to prioritize common interests, where and when these can be found. As the crisis deepens, ever fewer of the most pressing interests turn out to be common. And it's obvious that it doesn't take all that much to shine a glaring light on rifts and divisions within Europe. Thousands of years of history can't be polished off in a mere few decades.

The entire EU project, including the common currency, sounded great in times of plenty. When the plenty was gone, the whole project was found to be no more than a thin layer of glossy veneer that - only - temporarily hid all the age old differences from sight.

Moreover, there are fundamental differences in how various parts of Europe built up their financial systems even within the EU. Countries like Holland, Ireland, Portugal and the UK fashioned huge housing bubbles, while others like France, Germany and Italy did not. But the latter still managed to create huge problems for themselves, for instance by financing the bubbles in the rest of the Union, though not necessarily in the same ways.

Now that it's women and children first, saving France from drowning simply requires entirely different measures from doing the same with Germany, and Italy can't be saved with the same plans that Holland can. It is that simple. This week's meetings will try to come up with ideas that cover some sort of common ground to solve all the divergent crises, but the only way to do this would be to throw huge amounts of public funds at the mess, without any guarantee that any of it would work more for than a few months at best.

And it's simply not in Germany's, let alone Merkel's, best interest to throw that much money around. In other words, there no longer is a viable solution that would cover all different countries and interests (if ever there was one). And so everyone will do what it takes to save themselves, even if that means endangering others.

'Women and children first' can easily become a hollow phrase when there are not nearly enough lifeboats, when you run out of common ground.

In other news, the award for October's best new nonsensical term must go to the nitwits we see quoted talking about "haircuts that must be sustainable". How on earth do you push such a thing past your larynx? Sustainable haircuts? Want them comprehensible too?

Occupy Sustainable Haircuts?! Photo: EPA

Ashvin Pandurangi:

Kicking and Screaming in the Euro Sands

It’s common knowledge that when one finds oneself stuck in quicksand and slowly sinking, it is most important to breathe deeply and relax. Frantically struggling to escape the sand in a fear-induced, panicked frenzy will only lead one to sink faster and make the situation that much worse.

Well, at least that’s common knowledge for most individuals, but it is evidently very uncommon knowledge for leaders of large economies in modern society. Once the brainwashed collective finds itself in a predicament, it will be chaotic struggle until the bitter end. Exhibits A, B, C and D have all been spawned out of Europe lately.

For more than a year now, the European Monetary Union has been caught in wet, sinking debt-sand and has tried to escape by kicking and screaming its way out. First, the "solution" was to force over-indebted nations (Ireland and Greece) into more debt and gut their private economic infrastructure through austerity.

When that failed and the contagion spread, they flung even more debt at another debtor nation (Portugal) to see what would stick. After they sunk even further past their hips and towards their chest (Italy and Spain), they began screaming at each other about how best to create more debt and implement more devastating austerity.

That’s where the EMU finds itself now. Almost up to its neck in private, public and derivative debts that are rapidly imploding. Its chest is tightly constricted by austerity, which makes it that much harder to fill its lungs with air and stay afloat, and it only has one metaphorical hand above the surface, hopelessly clawing for salvation.

That hand is Germany and, when it gives up, there will not even be the appearance of hope for the Union to survive as it is currently structured. The last two weeks have been ones in which this sheer desperation is on display for the world to see.

It started with an announcement from Merkel and Sarkozy that a "comprehensive" and "sustainable" solution to the European sovereign debt crisis would be reached by the end of October. [The End of the Eurozone].

Essentially, they bet the farm that peripheral EU countries would be kept solvent, the core counties insulated from financial contagion when Greek debt is inevitably restructured and the European banks, with their highly inter-connected, cross-border exposure to bad debts, healthy. It only took a few days before it became clear that Spanish and Italian finances were sinking even faster into the debt-sand.

Merkel was then forced by economic and political reality to radically alter the previous language about a comprehensive solution, warning everyone that the EU Summit concluding on October 23 would bring no "dramatic course-changing events". [Political Solutions for a Financial Crisis].

Translation: we are still sinking and we are nearly out of breath. The hand of Germany remained clawing, however, and that sad fact apparently provided plenty of fodder for the mainstream financial media to keep some semblance of hope alive in the markets. On Tuesday October 18, The Guardian made the following announcement:

"France and Germany have reached agreement to boost the eurozone's rescue fund to €2tn (£1.75tn) as part of a "comprehensive plan" to resolve the sovereign debt crisis, which this weekend's summit should endorse, EU diplomats said.

The growing confidence that a deal can be struck at this Sunday's crisis summit came amid signs of market pressure on France following the warning by the ratings agency Moody's that it might review the country's coveted AAA rating because of the cost of bailing out its banks and other members of the eurozone."

The details of this alleged plan are irrelevant, because The Guardian’s report was immediately refuted by Dow Jones, who called it "totally wrong", and the following day we found out that it was, in fact, totally wrong.

France and Germany still could not agree on any of the significant issues, including if to leverage the EFSF, how to leverage the EFSF (Germany and the ECB firmly rejected France’s proposal to turn the EFSF into a bank that could borrow from the ECB), how much to leverage the EFSF, and if or how to help shore up capital for Euro-area banks. Soon after, it was clear the weekend Summit was destined to go nowhere fast.

By the night of Thursday October 20, it was announced that there would have to be a "second summit" occurring "no later than Wednesday" before any firm "resolutions" could be made public. Now let’s be clear here.

One could be forgiven if all of the above created the impression that, despite the barrage of unfounded rumors, developments in the European crisis response were occurring rapidly and were fluid, but the truth of the matter is that nothing has developed this entire time. The only thing that has happened is that European politicians and officials have publicly admitted they’ve sunken neck deep into the debt-sand and that they are well aware of it.

They are now going to spend the next three days coming to terms with that fact. The Germans, in particular, will be coming to terms with the fact that they cannot keep clawing at the surface forever, because it will not bring them any closer to escaping the debt-sand which threatens the EMU’s existence every single day. Germany’s finance minister has made absolutely clear that it will not approve of any plan to transform the EFSF into a leveraged bank. [1].

Well, if we can't make it a bank, say the French and others, let’s turn it into a bond insurer. Doesn't work? No problem, let's try turning it into a Special Investment (or Purpose) Vehicle. Anything goes, apparently, these days in Europe.

Furthermore, the German Budget Committee has stated that it will not allow EFSF guarantees to exceed €211 billion, which means it can only provide about €1 trillion (not enough) of insurance on peripheral bonds if everyone decides to go that route (not assured). [2].

It was also made clear that private investors would have to bear much more than 21% of losses on their Greek bond holdings. Perhaps even up to a 60% haircut, which would easily pull the trigger on the sniper rifles that have been training their cross-hairs on French banks, and the ratings agencies that have been [hesitantly] training theirs on French sovereign debt, aiming to render France yet another liability for Europe.

And remember this is for a country whose debt has been steadily increasing for years to reach over 160% of its GDP now. The Financial Times reports on the latest entirely unsurprising development on this front:

"The report also made clear European leaders are considering "haircuts" on Greek bonds far higher than previously known. The study determined that in order to bring a second Greek bail-out back to the €109bn agreed in July, bondholders would have to take a 60 per cent loss on their current holding.

That is significantly more than the 21 per cent haircut agreed in a deal with private investors three months ago. The analysis says that a 50 per cent haircut, increasingly considered the most likely scenario among European policymakers, would put the second Greek bail-out at €114bn, or €5bn more than the July deal. "Recent developments call for a reassessment," the report said. "The situation in Greece has taken a turn for the worse."

Yet another bombshell was dropped on the six-day "marathon" summit by the EU and IMF in a joint report, which essentially stated that Greece could end up devouring the entire €440 billion in firepower that the EFSF currently has. If that’s truly the case, then all of the hotly contested debates about whether to leverage the fund to one or even €2 trillion are made irrelevant.

Greece’s relatively tiny economy would swallow at least 25% and most likely 50% of the whole fund. The Telegraph’s Bruno Waterfield reports:

"…without a [Greek] default, the Greek debt crisis alone could swallow the eurozone's entire €440 billion bailout fund - leaving nothing to spare to help the affected banks of Italy, Spain or France.

An EU already rocked by divisions between France and Germany over how to increase the "firepower" of the European Financial Stability Facility (EFSF) in order to save the wider eurozone from Greek contagion now faced the prospect of losing it all in one go."

It gets worse for the sinking Union. The IMF has now told the Europeans that they must impose at least 50% haircuts on Greek bondholders, or else it will not disburse its contribution to the Greek bailout which amounts to a whopping €73 billion. That is more than twice the original percentage agreed upon in June, and if investors (Euro banks) don’t play ball and destroy their balance sheets, Greek will technically be in default.

Then, there is nothing to stop the EMU from sinking in their debt-sand, the contagion from spreading to Italy and Spain (and maybe France) and the CDS contracts written by American banks from taking them down as well.

First Bloomberg reports on the lack of any idea about what solvency problems the banks are facing and how to deal with them:

"A 10-hour meeting in Brussels failed to yield a blueprint for banks’ role in a revamped Greek rescue as European finance ministers haggled over what they called a "credible firewall" against fallout from deeper writedowns.

The ministers’ meeting broke up at about 7 p.m. after reaching agreement that European banks may need about €100 billion ($139 billion) in capital after marking their sovereign-debt holdings to market values, according to a person familiar with the discussions. This amount is needed to reach a core tier 1 capital level of 9 percent based on a European Banking Authority test, said the person, who declined to be identified because discussions are private.

The struggle to get an accord on bank capital was just one piece of solving the two-year-old financial crisis. Governments also are pushing for deeper writedowns on banks’ holdings of Greek debt, a step the investors are resisting. "

The IMF would no longer be willing to pick up a third of the total bill for rescuing Greece, a contribution worth €73 billion, unless European banks were prepared to write off 50 per cent of Greek debt. "It was grim. The worst mood I have ever seen, a complete mess," said one eurozone finance minister. "

The Telegraph article then goes to explain just how bitter the mood is between the German Finance Minister Wolfgang Schäuble, French Finance Minister Francois Baroin and IMF Head Christina Lagarde.

The former doesn’t want anything to do with expanding bailouts for anyone at this point, the latter is screaming to everyone that the math just isn’t working and the French minister is begging everyone to help him save French banks from their all but assured demise. Merkel and Sarkozy are floating around there somewhere too, giving each other the "evil eye" when they are not simply shouting at each other to no end.

On top of all that, the European Council President, Herman Van Rompuy, spewed out something about a plan to create a single European Treasury that could override national budgets and unilaterally impose austerity at will, to be located in Frankfurt or Paris. [3].

That may have also been the point where just about everyone else present started throwing tomatoes, or whatever was being served and within reach, at Rompuy's face. Basically, it was a ridiculous suggestion that only served to create even more animosity between all of the countries reluctantly attending the joke of a "Summit" where Germany and France endlessly argue and tick everyone else off.

So while the still clueless US equity investors wait with baited breath for some kind of "comprehensive" announcement on Wednesday, the people allegedly discussing the measures cannot even stand to be around one another anymore. They have been rapidly sinking into the abyss for months now, and who can blame them for not having even an ounce of hope or civility left.

They will surely come up with something to say about increasing the "firepower" of the EFSF, creating a "credible" plan for restructuring Greek debt and backstopping Euro banks, but they won’t believe any of it and they won’t expect anyone else to either.

For all the reckless motions of conditioned bailouts, panicked conferences, and incessant shouting, screaming and clawing, the Euroland has simply left itself up to its eyeballs in debt-sand, and that has, in turn, left it with no more hope, comfort or credibility in any meaningful sense of those words. Rumors will keep coming in and going away even faster, but the muted sense of despair and an approaching denouement is what really lurks beneath.

It will not be very long before the debt-sand envelops the Euroland’s entire body and leaves only one cold, dead hand as a reminder of what was once a Union sinking, but still alive, if only for the briefest of moments.

It was supposed to be an evening for celebrating Jean-Claude Trichet's nine years at the helm of the European Central Bank (ECB).

But as the orchestra played Beethoven's Ode to Joy in Frankfurt's Alte Oper, the city's concert hall, on Wednesday evening, the masterplan to rescue Europe's single currency was beginning to unravel. Europe's big test was about to become a whole lot more difficult.

Earlier the same afternoon, EU officials were confident that deep rifts between France and Germany on how best to save the euro could be patched under the warm glow of European unity. The day before, Nicolas Sarkozy, the French President, had warned that the divisions risked both "the destruction of the euro" and "the destruction of Europe". Looking sombre, President Sarkozy assured French MPs that he would be on a plane to Frankfurt to patch up a deal on increasing the "firepower" of the eurozone's European Financial Stability Facility (EFSF) bailout fund, currently worth €440bn.

Fate was to intervene when Mr Sarkozy's wife Carla Bruni entered Paris's La Muette clinic to give birth to their daughter, Giulia, on Wednesday afternoon. "That's it the meeting's off, Sarkozy can't miss their first child being born," despaired one EU aide in Brussels. But these are truly desperate times and the world of officialdom was to be proved wrong.

So acute was the split between France and Germany and so fragile the prospect of putting together a "big bang" fix for the euro in time for this weekend that Sarkozy abandoned his wife in the throes of labour to travel to Frankfurt. His urgent mission was to win over Angela Merkel, the German Chancellor, to supporting a French plan to "leverage" the EFSF by allowing it access to the theoretically unlimited funds of the ECB.

Only by "backstopping" the EFSF with the ECB, he argued, could the eurozone deliver a "shock and awe" multi-trillion fund that could convince the markets with a pot big enough to recapitalise banks and to buy up distressed Spanish and Italian bonds. Naturally, "leveraging" the ECB also had the attraction of taking the heat off France's national budget, sparing the country's under-pressure AAA rating in the last critical six months before too-close-to-call presidential elections.

Sarkozy's dash from the maternity clinic was in vain. "Nein, nein, nein," was the answer from Merkel, with the support of Trichet, the French ECB chief. Europe's central bank could not be used to boost the EFSF because of a 20-year EU treaty clause forbidding the union from using its cash to save European governments.

Unlike the EFSF, an ad hoc inter-governmental "special purpose vehicle" based in Luxembourg, the ECB is governed by the detailed chapter and verse of European law. "If the ECB could act like a national central bank that would make life a hell of lot easier, problem solved, but that runs up against the treaties and Germany's cult of the Bundesbank. Sarkozy was told 'game over'," said a senior EU diplomat.

The ECB celebrations broke up in acrimony. Christine Lagarde, the head of the IMF and former French finance minister as well as a supporter of bringing in the ECB's big guns, left first with no comments to the waiting press. Next to sweep past the cameras and microphones without a word was Sarkozy, pale with rage and the strain of being a presidential father who had just missed his child's birth on a futile mission.

Jose Manuel Barroso, the European Commission president; Herman Van Rompuy, the president of the European Council; and Olli Rehn, the economic affairs commissioner, were next to leave. A stony-faced Merkel departed by the back door. "It was moment that the EU nearly broke," said one official.

Pleading for "compromise" and a decision by a deadline of Sunday's eurozone summit in Brussels, Barroso began Thursday morning by circulating four "strictly confidential" and complex papers on how to both increase the EFSF's clout and set out the rules for it to recapitalise banks and buy distressed bonds. The intervention did not go well, with Germany again proving to be an obstacle.

Following a ruling in Germany's all powerful constitutional court, Merkel was legally bound to seek a prior mandate on the EFSF from the Bundestag and German MPs were not playing ball. The issue was not helped when MPs expressed vocal fury over getting the commission's four papers in English rather than German. Tense talks degenerated further when, after a hurried translation, the MPs realised that the proposals did not include figures on how the EFSF's power could be increased without increasing Germany's €211bn contribution to the fund.

After a two-hour grilling by the Bundestag's budget committee a visibly rattled Wolfgang Schäuble, Germany's finance minister, left the meeting refusing to comment on whether the crisis eurozone summit this weekend would have to be called off.

Minutes later, after being seen shouting into her mobile phone, presumably talking to Schäuble, Merkel cancelled her planned Friday morning speech to MPs and Berlin phoned Brussels to ask that Sunday's summit be postponed until Wednesday. "Without any concrete proposal for increasing the efficiency of the fund the chancellor can't present a complete set of proposals," said Norbert Barthle, a senior member of the chancellor's Christian Democrats.

As news came through to Brussels that Mrs Merkel wanted to cancel the summit – already postponed once, causing the markets to plunge – officials were "literally tearing at their hair", said one civil servant. Herman Van Rompuy, who chairs summits of EU leaders, had to break the news to Paris.

"There was an explosion and the Elysee insisted that the meeting must go ahead. Delay would lead to a market wipeout on Monday and French banks and France's AAA would be in the frontline," said a source. After personal entreaties from Sarkozy, Van Rompuy and Barroso, the German chancellor accepted that a three-day series of meetings over the weekend would continue as planned. "But instead of a final decision on Sunday, she will take back a provisional deal to the Bundestag on Monday or Tuesday and hope it's enough to get it though at a second summit on Wednesday," said a diplomat. "Europe is at the brink. There are no good options anymore just lesser evils that people must live with."

Without the ECB's firepower, the options are ugly and, officials freely admit, smack of "smoke and mirrors" with too much reliance on the very leveraging and financial products the EU has previously blamed for causing the initial banking crisis. It was that mess, of course, which spilled over into the sovereign debt crisis that has threatened to tear down the euro.

The current front-runner for leveraging the EFSF is the "first loss insurance" option or "Allianz plan". Under this option a proportion of sovereign debt risk would be underwritten by the EFSF - between 20pc and 25pc is the proposal - in an intervention that would pay the fees for private investors to take out insurance on bonds. A higher insurance subsidy, of up to 40pc, could be given form Greek, Irish or Portuguese bonds.

In this way each €100bn of the EFSF could be leveraged as high as €500bn. Such a move would take the assets at the disposal of the fund, after its commitments in Ireland and Portugal, to €1 trillion. "But one trillion is not the multi-trillion answer markets want," said one diplomat. While Germany "can live with it", France is uneasy with the scheme, which could impose new burdens on its national budget, putting its AAA status at risk.

"The problem is that if the firepower is to be artillery rather than small arms then it immediately has a cost implication in the form of capital assets or guarantees held by the EFSF," said an EU official. France, via BNP Paribas, has intervened, calling for the EFSF to write credit default swaps (CDS) for investors buying Spanish or Italian bonds.

"Can the euro be saved by spreading the debt and slicing and dicing the EFSF's capital or guarantees into highly complex financial products?" asked one national finance ministry official. "It's looking much more like a fiendishly clever conjuring trick, or even a Ponzi scheme, than the big bang the markets want."

The gloom is even deeper and darker over discussions on the size of the haircut or writedown of the value of Greek sovereign debt to be passed on to private investors, a decision that could threaten banks with high-exposure to the debt, especially in France.

Germany, the Netherlands, Britain and others "take the view that there needs to be a substantial writedown" of up to 50pc to 60pc on the sovereign debt, according to officials. The view is also said to be held by the IMF, an important player, because it is underwriting a third of the bailout to Greece. "No one thinks Greece can pay back debt worth 180pc of their GDP amid recession, social conflict and rocketing unemployment," said a senior source.

But France is very worried about the possibility of an involuntary haircut and a "credit event" that will see its banks pushed to the limit of credit-worthiness with massive implications. According to diplomats, France can accept that the July 21 package suggesting a voluntary write down of 21pc can be reopened but only in the 35pc to 45pc range.

If the haircut is kept below a "credit event" level, then France will accept a European Banking Authority plan to set capitalisation levels at 9pc but, say diplomats, only if that expressly rules out new cash injections from the government to French banks. Germany takes a different view, telling France that if it wants to have a big bang EFSF, it needs to bite the bullet of substantial costs on top of a Greek haircut and accept the pressure on French banks.

"Is there room for a Franco-German deal behind an EU agreement that saves the eurozone without France losing its AAA status at presidential election time? Can the eurozone function at all if France, its second largest economy, loses its AAA?," asked an aide to a senior EU official. "If an unstoppable force meets an immovable object, what happens? We might be about to find out."

Europe's leaders are threatening to trigger a formal default on Greek debt and risk a “credit event” if banks refuse to accept losses of up to €140bn (£120bn) on their holdings. Hardline eurozone members, backed by the International Monetary Fund (IMF), delivered the ultimatum this weekend after an official report found that in a worst-case scenario Greece could need a second bail-out of €450bn – twice the current package and more than the entire €440bn in the eurozone’s rescue fund.

Vittorio Grilli, a senior EU official, travelled to Rome yesterday to present the “take it or leave it” deal to the Institute of International Finance, which is leading the negotiations for the banks. “The only voluntary element for the banks now is to take a 50pc haircut or face a credit event, a default,” said an EU diplomat.

The threat marks a dramatic change of stance in Brussels, and follows early warnings that a Greek default would set off a chain reaction that would result in a worse financial crisis than in 2008. Although wary about the markets, they are now thought to believe that a “big bazooka” solution could contain the crisis in Greece.

The “haircut” would be accompanied by details of plans to recapitalise the banks and reinforce the European Financial Stability Facility (EFSF), the €440bn bail-out mechanism. If the banks called the EU-ECB-IMF troika’s bluff, they would potentially face nationalisation.

A “credit event” would risk triggering credit default swaps – the scale of losses from which cannot be accurately quantified.

Finance ministers, including Chancellor George Osborne, were locked in discussions all day yesterday over the details of the bank recapitalisation. He emerged from talks saying that “real progress” had been made on plans to strengthen European banks.

Ministers were thought to have agreed that banks may need about €100bn in capital, increasing their core tier one capital ratio to 9pc. But, the details of these plans were not yet clear.Europe’s banking lobby, dominated by French financial institutions with a high exposure to Greek debt, have protested that any haircut greater than 40pc is too much.

But Mr Grilli, who chairs the EU’s powerful economic and financial committee, which does the backroom work for European finance ministers, will tell the banks the IMF recommends a 60pc haircut.

The ultimatum will say that a 50pc private sector contribution is the minimum that can be accepted and, even then, the EU will have to put in an extra €4.5bn for Greece. To ensure the banks can withstand the losses, they will be made to raise at least €100bn over the next six to nine months.

French banks are particularly exposed, but UK officials are confident British banks will escape unscathed. In July, European banks offered a “voluntary contribution” of 21pc writedowns – an offer the banking sector has struggled to deliver and which is widely mistrusted by governments due to the collateral lenders are asking in return.

Jean-Claude Juncker, the chairman of the euro group of finance ministers, said: “We have agreed that we have to have a significant increase in the banks’ contribution.”

The development is a victory for the IMF, which typically requires a default and a currency devaluation as well as austerity as part of a rescue programme. In Greece’s case, the ECB and European Commission (EC) have insisted the programme is limited to austerity. The ECB and EC fought with the IMF to keep haircut scenarios out of a joint troika report on Greece, delaying its completion by a month .

Just when the eurozone governments thought it could not get worse for Europe's single currency, it did.

Shell-shocked EU finance ministers meeting in Brussels on Saturday were already reeling from the worst Franco-German rift for over 20 years and a fractious failure to resolve the problems that have brought Greece, and the euro, close to the brink.

But then a new bombshell hit as a joint report by the EU and the International Monetary Fund (IMF) warned that, without a default, the Greek debt crisis alone could swallow the eurozone's entire €440 billion bailout fund - leaving nothing to spare to help the affected banks of Italy, Spain or France.

An EU already rocked by divisions between France and Germany over how to increase the "firepower" of the European Financial Stability Facility (EFSF) in order to save the wider eurozone from Greek contagion now faced the prospect of losing it all in one go.

As dark-suited finance ministers contemplated the pains au chocolat laid out on their desks alongside their talking points and position papers, Jan Kees de Jager, the Dutch finance minister, told colleagues: "We've got to get real. People are talking about new defences but with one gulp the whole €440 billion could be gone, leaving the eurozone with no protection at all."

Compounding the trauma, Christine Lagarde, the French finance minister turned IMF chief - and one of the few key players who appeared to be enjoying herself in her new headmistress-like role - issued a grim warning to her former European peers.

The IMF would no longer be willing to pick up a third of the total bill for rescuing Greece, a contribution worth €73 billion, unless European banks were prepared to write off 50 per cent of Greek debt. "It was grim. The worst mood I have ever seen, a complete mess," said one eurozone finance minister.

In a change to the normal euro summit venue in the pink marble clad Justus Lipsius building, finance ministers were meeting next door to allow security staff to carry out a 24 hour security sweep before Europe's leaders arrive on Sunday.

The relocation to an administrative block, the Lex building, added to the flat and leaden atmosphere as ministers trooped into neon strip-lighted, brown carpeted office space without natural sunlight. Outside the security cordon on the other side of the road to the building's entrance on Avenue Livingstone, anarchist graffiti on a wall proclaimed in French: "After Greece, Belgium, the insurrection is coming."

There were already moments of near insurrection inside, however. The Joint IMF and EU report gave the eurozone's haircut hawks - those, led by Germany, who want the banks to accept a bigger loss on some of the money loaned to Freece - the opportunity to give "a bloody hiding" to both France and the European Central Bank. Both have been resisting any talk of a Greek debt default for fear it would damage French banks and rock the stability of financial institutions.

According to insiders, Wolfgang Schaeuble, Germany's finance minister, could not resist taking an "I told you so" approach - he had been, after all, the first to call for an "orderly" default for Greece 18 months ago, at a time when the cost of such a move was less than one third of the price today. "Schaeuble is a man who does not mince his words, whose reputation for harshness and arrogance is well earned. He was, frankly, unbearable," said one diplomat.

Francois Baroin, the young and inexperienced French finance minister, attempted to hit back, complaining that the IMF's default medicine would hit France the hardest; the country's banks are highly exposed and could threaten its "untouchable" AAA rating.

But Mrs Lagarde, who had held his post until taking up the IMF job this summer, "shut him up" by brandishing the report and pointing to it its detailed figures. "She really slapped him down - and in perfect English too, a language he cannot speak," said a diplomat.

It is an odd fact that eurozone meetings are generally conducted in English, the language of international finance, and that Mrs Lagarde enjoys using it. It seems to have added to the relish with which she conducted herself yesterday, coolly enjoying what insiders observed was her first opportunity to engage in political and intellectual combat with her French - and other - colleagues.

Interpersonal relations between eurozone leaders have hit an all-time low, reflecting sharp disagreements between Germany and France over using the ECB to bailout the euro and presenting an additional obstacle to finding a "grand solution" to Europe's debt crisis.

Nicolas Sarkozy's "two faced" personality has been cited as a major factor in his dysfunctional relationship with Angela Merkel. During one-to-one, face-to-face meetings with the German Chancellor, the French President is said to be "syrupy", "ladling on the charm", but when her back is turned or she leaves the room, Mr Sarkozy changes tack.

Chancellor Merkel is said to have been deeply wounded by one anecdote that Mr Sarkozy is said to have told another head of government about her. "She says she is on a diet and then helps herself to a second helping of cheese," the French president allegedly said after a dinner meeting with Mrs Merkel. Such cattiness will not have been forgotten by Mrs Merkel when she sat down to dine with Mr Sarkozy last night in an encounter billed as a "make or break" moment to save the euro by patching up Franco-German relations.

A row between the pair in Frankfurt on Wednesday overshadowed leaving-do celebrations to mark the end of Jean-Claude Trichet's nine years as the head of the ECB. "Their shouting could be heard down the corridor in the concert hall where an orchestra was about to play the EU's anthem, Ode to Joy," said an incredulous EU official.

Finance ministers - including George Osborne, the Chancellor - expressed frustration on Saturday that their emergency meeting could take no decisions of substance until Mrs Merkel and Mr Sarkozy had buried the hatchet. "This Ecofin meeting has been reduced to an academic seminar, an exercise with absolutely no purpose," complained one finance minister.

So pointless was the gathering, that Didier Reynders, the Belgian finance minister, left early to attend the world premiere of the new Tintin film, The Secret of the Unicorn. Mr Reynders will be presenting Steven Spielberg, the film's director, with the royal insignia of a "Commander of the Order of the Crown".

As well as the breakdown of the Franco-German motor, the EU is facing a rebellion from Italy, Spain and others over "imperious diktats" issuing from Paris or Berlin. And to cap it all, as The Sunday Telegraph can now reveal, Herman Van Rompuy, the EU president who is regarded by many as too close to Berlin, angered many countries when he made confidential proposals for the creation of a European finance ministry.

His plan, which has considerable backing from the growing body of EU bureaucrats who see a unified EU treasury as the only solution to the problem of countries spending more than the euro can stand, would mean a centralised body able to override national budgets and enforce cuts on profligate governments.

Anything like it would be the most radical step in the history of the European Union, going further than any vision of the founding fathers who drew the line at giving away fiscal and military sovereignty. "People were furious," said one diplomat from a small eurozone country. "It is bad enough that these ideas are all dreamt up by German or French officials. Even worse, Van Rompuy had the arrogance to suggest that the EU finance ministry should be based in either Frankfurt or Paris."

As talks dragged through Saturday to satisfy Italian and Spanish concerns over "arcane drafting language", a frustrated George Osborne, the Chancellor missed his flight back to Manchester, the closest airport to his Tatton constituency.

Jean-Claude Juncker, the prime minister of Luxembourg and chairman of the eurogroup of finance ministers, joined journalists outside the security cordon of the EU summit venue for a cigarette. He has been forbidden to smoke inside by Mr Van Rompuy. "I needed a break," he said. "I have no idea how long all this is going to take."

Although Greece has received approval for a sixth financial aid tranche, amounting to 8 billion euros ($11 billion), from Eurozone finance ministers on Friday, the country’s problems are far from over. Indeed, as senior government officials from across Europe meet in Brussels, Belgium, this weekend, alarm bells are spreading that Greece’s debt woes will spill over to all other euro nations.

British Chancellor of the Exchequer George Osborne warned to reporters: "We've had enough of short-term measures, sticking plaster that just gets us through the next few weeks. The crisis of the Eurozone is a real danger to all of Europe's economies, including Britain."

However, fairly or unfairly, Greece has become the "symbol" of Europe’s near-collapse, and much attention has been focused upon its society, which is crumbling. Deeply mired in a grave economic crisis, Greece is witnessing wave after wave of strikes and protests against the government’s wildly popular program of austerity, which calls for, among other things, massive job cuts in the public sector, reductions and/or freezes in state pensions, tax hikes and an increase in the retirement age.

Under a strict mandate from the European Union (EU), the International Monetary Fund (IMF) and the European Central Bank (ECB) -- the dreaded "Troika" -- the Athens government is under extreme pressure to cut costs, lower spending and reduce a burdensome mountain of debt.

Ben May, an analyst at Capital Economics in London, recently warned: "If the [Eurozone's] core economies demand that Greece passes further fiscal measures, it could prompt Greece to try to implement another debt restructuring as soon as next year. Exiting the Eurozone is a real possibility."

However, Athens' government officials have hewed to the line that they are committed to remaining in the currency bloc. Indeed, on Friday, Greek Finance Minister Evangelos Venizelos vowed in a statement: "[The] decision by the Eurogroup for the Greek program and the sixth tranche is a positive step ... which secures 2012 fiscal targets and sets the ground for the necessary structural changes."

That won’t mean much to millions of Greeks who are deeply concerned about their country, considered the "cradle of Western civilization," which appears to be on the brink of social and economic collapse.

The numbers are stark and depressing. Unemployment has climbed to 16.5 percent in July (the second-highest rate ever recorded in the country and among the highest levels in the Eurozone), from 16.0 percent in June -- and the rate is sure to spike even higher as the government continues to lay off masses of public sector workers.

"The pace of decline in employment in basic sectors of the economy, such as construction, retail and wholesale trade, could not be mitigated from seasonal hiring in tourism," said Nikos Magginas, an economist with the National Bank of Greece. Magginas warned that he expects the unemployment rate will exceed 17.5 percent (an all-time record high) by the end of the year.

Joblessness is particularly hammering Greek youth – an astounding 42 percent of people between the ages of 15 and 24 are without work (double the level from just three years ago). The Greek economy is on track to shrink for a fourth consecutive year -- GDP is expected to contract by 5.5 percent in 2011. The EU and IMF do not expect a recovery to occur until 2013 at the earliest.

Meanwhile, worries are spiraling that Greece may eventually default. Indeed, some experts believe default is inevitable. Prior to Friday’s news of the bailout tranche approval, U.S. economist and Harvard professor Martin Feldstein told CNBC that Greece will indeed default and would be best advised to exit the EU. "Somebody may write the check so that they get past the deadline, but there is no question Greece is going to default," he said.

He cited that Greece labors under a debt-to-GDP ratio of 150 percent, very high unemployment, while is "GDP falling at a very fast pace." Feldstein also noted: "I think if they [Greece] could [leave the EU] without being punished by the rest of the EU members, that would be a good thing for them."

He added that the EU’s rescue fund -- the European Financial Stability Facility (EFSF) -- is likely insufficient to resolve Greece’s financial woes. "The EFSF is big enough for Greece but it’s not big enough for Italy or big enough for Spain," he said. "So that won’t do it. What they’re talking about in terms of recapitalizing the banks is telling the banks that they better go to the capital markets first. If they don’t make it, well, then they can look to their national banks. If that doesn’t work, well, then who knows?"

Another problem for Athens is the anger of Greece’s powerful unions, which have called for huge strikes that have paralyzed the nation. Costas Tsikrikas, chairman of the 500,000-member Civil Servants' Confederation (ADEDY) union, blasted the government of Prime Minister George Papandreou, accusing it of destroying the Greek economy by imposing excessively harsh austerity cuts.

"This will exacerbate recession, unemployment ... and state revenues will continue to fall, creating a death spiral. It must not continue," Tsikrikas told Reuters. "The government has to call on the rich to contribute. Workers look more like squeezed lemons now, they can’t take it anymore. The state must take the money from those who have the income to pay the taxes. The rich, the big companies that use the workforce of this country -- don’t they owe the country and its people something?"

Tsikrikas also urged Papandreous’s government to enforce laws against tax evasion by the wealthy, particularly doctors and attorneys. "People are right to want justice, [for] the burden equally shared, a just tax system and a crackdown on tax evasion," he said.

Interestingly, Tsikrikas scoffed at the notion of Greece exiting the euro. "It is the EU’s duty to help [us], because this is how it also helps Europe as a whole and the common currency," he said. The union boss also pointed to policy mistakes and strategic errors by the Athens government with respect to managing the economy. "[The government] has to promote Greek products, our services, tourism and shipping, the country’s natural beauty," he said. "It must also make use of all energy sources, solar and wind power."

The blame, Tsikrikas insisted, lay entirely on the political class, not the public, despite complaints that the public sector workforce has become too bloated and corrupt. "The crisis is not the public sector’s fault," he said. "The ones to blame are the main parties and governments that used public sector workers in their hunt for votes, treated public administration as if it was a form of loot. We’ll see whether the government can make it through tomorrow."

The economic catastrophe will undoubtedly spur mass emigration, especially among young and educated Greeks who have no hope of finding a job at home. The global Diaspora of Greeks already numbers roughly 4 million (versus about 11.2-million Greeks in the homeland). According to the government’s own figures, at least half a million Greeks have already departed over the past ten years.

Dr. Takis Pappas commented to International Business Times that he "has already seen several of my friends and acquaintances doing so [emigrating]… and, in fact, I am one of them. Historically, Greeks are a people of the Diaspora and, as such, they are prepared to go when there are opportunities. I think that, this time, many will eventually end up in Australia."

Pappas is a Marie Curie Fellow, Department of Political and Social Sciences at the European University Institute, Florence, Italy; and also Associate Professor of Comparative Politics, University of Macedonia, Thessaloniki, Greece. Indeed, according to Australian media, thousands of Greeks have already applied for visas to move Down Under, where skilled immigrants are desperately needed, particularly in health care, engineering, construction and automotive and mechanical trades.

Lancia Jordana, of the Immigration Department, told Australian media: "Because of the situation in Greece, people have seen this as an opportunity. But we need to have Australian employers who are interested in sponsoring people. The demand has outstripped supply."

Potential emigrants are yearning to leave Greece. One Greek woman, Argyro Tsigonaki, 53, who is moving to Melbourne, Australia, told the Toronto Star newspaper of Canada: "The situation in Greece will not get better for at least the next decade, and next year will be even worse. I feel like our business here is finished. I’d prefer to be a homeless person in Australia, if it comes to that, than a homeless person in Greece."

The real estate specialist also said: "I thought my future was all fixed. But if I stay here, I can no longer be sure of receiving a pension after retirement that I can live on. It’s very disappointing and frightening to start all over again. I’m sad to go. I don’t want to leave my children. But I have faith in myself — more faith than I have in this country."

Indeed, Australia and the United States apparently beckon Greeks, while the other EU nations seems less attractive than before due to the perceived fear of contagion of the debt crisis across the continent. Tsigonaki further lamented: "We spent 15 years building up our business. But nobody is buying houses any more. Everybody wants to sell. The new taxes are strangling all small businesses, like ours. It’s as if there’s no line that the government is unwilling to cross."

She also described the housing market crisis in Greece, which, as in the United States, was exacerbated by easy loans from banks. "I tried to convince buyers, ‘You don’t need that big house with four bedrooms; start with something smaller,’ she told the Star. "But it was so easy to get loans and interest rates were so low. Nobody wanted to wait until later. Now they can’t pay their mortgages, can’t pay their taxes and they’re desperate to sell, even if it means taking huge losses. My business has dropped off 30 percent from two years ago."

Tsigonaki’s husband, Christos Bavelis, an economist, slams the government’s handling of the crisis. "The whole social network in Greece is breaking down," he fumed. "You have people in their 30s and 40s moving back in with their parents because they’re losing their homes or they can’t afford rent. Revenue is leaving the country to pay our international creditors. This is causing a death spiral for our economy. I love Greece but I don’t recognize my country anymore."

Greece witnessed mass emigration just after World War II, primarily to Western Europe, the United States, and Australia (which already has a significant Greek community). However, after the 1973 oil crisis, emigrants largely returned to Greece, particularly from Germany and the U.S. In the 1990s and afterwards, Greece itself became a Mecca for foreign immigrants, particularly from Eastern Europe, the Middle East and South Asia. But now, with jobs vanishing, even they are seeking to depart the country.

How did it all come to this? Pappas thinks this is the worst crisis since the nation became a republic in 1974. In July of that year, the military government of Greece fell, leading to the return of former Prime Minister Constantine Karamanlis from self-imposed exile. Greece had been ruled by a right-wing military junta since April 1967. "What makes the current scenario even worse, and probably insoluble, is that the present economic and financial crisis has been caused chiefly by an enormous political crisis," Pappas said.

"It is politics that have, in the first place, led Greece to the present day as a clear example of a failed state." He noted that when Greece first joined the euro, there was widespread support for it among the populace. "The whole thing was presented to them by the politicians as manna from heaven or, better, as their passport to prosperity and growth," he said. "And, unfortunately, there was at the time a fundamental misunderstanding, or confusion, between productivity and consumerism."

The notion of a "failed state" is typically applied to fragile, chaotic and volatile Third World nations that cannot provide basic services to its people like Somalia and Pakistan. But in recent months, the notion of Greece becoming (or already having become) a "failed state" is gaining more currency.

Indeed, in an editorial that appeared in The Irish Times over the summer, Dan O’Brien wrote that Greece is a "borderline failed state. Its society lacks cohesiveness and is deeply divided. Its economy is in shock. If the country’s history is any guide to its future, there is serious trouble ahead."

O’Brien gloomily added: "The crisis now presents nothing but threats and risks. This, in many ways, is unsurprising. The chronic dysfunctionality of the Greek state is long established. Since independence almost two centuries ago, Greece has experienced civil war, uprisings, mass displacement of people, dictatorships and terrorism." O’Brien also cited high levels of corruption in Greece. According to a report from Transparency International, Greece was the most corrupt nation in developed Europe in 2009 and ranked 57th in the world.

He concluded: "There is very little reason to be optimistic about Greece. Its economy, politics and society don’t work. This is not only very bad for Greeks; it is also bad for the people of the sixteen other countries in the Eurozone. If [Greece] implodes, it may well bring the single currency [euro] down with it."

Pappas thinks there is some support among the Greek public to simply declare a default, take the bitter medicine and exit the euro. "It is a very diffuse and irrational feeling that cognitive psychologists often detect in people who are found in acute crisis situations," he said.

The man at the center of the Greek fiscal crisis is probably Prime Minister George Papandreou, whose Panhellenic Socialist Movement (PASOK) party was founded by his father Andreas in 1974 following the establishment of democracy in Greece.

The economic crisis has put PASOK in a hopeless and thankless position – although it identified itself as a "Socialist" party, the exigencies of the current emergency has forced it to push for huge job cuts, drastic spending reductions and to engage in heated rhetoric against unions who are adamantly opposed to the austerity program.

Typically, it is the right-wing parties in Europe that advocate for such acts of harsh economic severity, which places PASOK in a very uncomfortable position ideologically. Indeed, some PASOK MPs have already resigned, including Thomas Robopoulos, a former deputy. In his letter of resignation, Robopoulos wrote: "I can no longer continue to vote without knowing what I’m voting about ... to vote for unjust and unpopular measures under threat that the government will collapse."

His resignation gave the PASOK party 153 seats in parliament, still a majority, but further hurts Papandreou’s credibility and confidence in his administration. However, Pappas commented that PASOK "has never been a truly Socialist party. Amidst the crisis, PASOK has not had the luxury of implementing the policies of its liking. [Rather], it has been obliged to follow the diktats of the troika [EU, IMF, ECB]."

While more PASOK MPs may quit as a protest against austerity, Pappas said that a greater concern would be the fall of the current government, which would be an ominous development for Greece’s future.

Bankers’ reaction to the latest flood of earnings statements has probably been one of relief. Although results were mixed – Goldman Sachs’ second-ever quarterly loss as a public company was particularly telling – they were decent enough that bank executives must hope they can get through unscathed by too much criticism.

Those who look under the surface, however, and take time to reflect on what they see, may find evidence of just how deep the banking sector’s social and political predicament is.

Some big US banks reported year-on-year increases in third-quarter profits. But the results appear a lot poorer when we peer under the hood of the headline numbers. In most cases, banks have booked the unrealised profits from marking to market the value of their own debt to their creditors.

In other words, growing market fears about banks’ solvency – which are driving down the price of their bonds and raising their cost of doing business – are turned to advantage in the profit and loss statements. This is to combine the black magic of leverage with the alchemy of mark-to-market accounting.

If Eurostat, the European Union’s statistics arm, allowed Greece to use the same trick, Athens would now be flaunting a public sector surplus bigger than Norway’s. There are two different lessons here – one for pessimists and one for sceptics.

The pessimistic reading is the more obvious one: it is that the banks – like the rest of us – live in a completely different world from that of before the crisis. The easy profits of the boom years are much harder to come by.

What is less clear is how permanent this is. If the results are an effect of tighter regulations – even if most of them have yet to come into force – then banks just have to get used to this brave new world. If they reflect a stumbling world economy, banks can hope for better times when stagnation finally gives way to recovery.

The sceptic’s interpretation is more subtle. The bizarre accounting trick by which banks record profits from their own weakness, raises a question: can we ever meaningfully know how profitable a bank is? We can, of course, measure how much cash is taken out of it to benefit its employees and shareholders. But that need not bear much relation to how much value the bank has created – so fleeting a quantity as to be almost unknowable.

The value created by a bank is the gain from financial intermediation: the difference between the return creditors receive on their savings (the bank’s liabilities) and the return that can be made from financing investments (its assets). But until any such investment is completed, these numbers are indeterminate, depending as they do on the success of the investment project itself and the economic conditions that influence it (including the ongoing availability of financing).

So it is only for a bank that is being wound down that one can decisively ascertain what contribution it has made to economic value. It is not too much of a stretch to paraphrase the ancient Greek lawmaker Solon on humans and happiness: do not pronounce a bank profitable until it is dead.

This radical indeterminacy of value is in the nature of long-term financial claims. Earlier generations of economists were more attuned than current ones to the difference between risk – which can be quantified and tamed through knowledge of probability distributions and correlations – and uncertainty, which defies such treatments.

Perhaps this is because the two require different mental attitudes. While we have made great advances in the calculating mindset appropriate to control risk, we have neglected the kind of humble, intuitive wisdom with which we must confront uncertainty.

What we can know is this. First, the enormous growth in financial claims of uncertain value during the boom led to huge losses in the bust. The frightening realisation that we do not know what we thought we knew (about how much our claims are worth) is the cause of the current crisis of confidence and the real economic hardship it has produced.

Second, the malleable nature of the values they manage has not stopped bankers from securing a safe stream of wealth to themselves. "Guaranteed bonuses" are on the rise again; fixed salaries have gone up; and David Viniar, Goldman’s chief financial officer, says that when revenues are low, the share set aside for compensation tends to be higher.

This, more than anything, is what has angered people around the world: that one segment of society should inure itself against the pain it has helped inflict on everyone else. The protests by the "indignant ones" have finally reached Wall Street, where the whole mess began. It is true that the protesters only articulate their indignation, without setting out any realistic alternative. But it is a big mistake to dismiss these voices for that reason.

It is entirely reasonable for people to focus on the things they know for sure have gone wrong. The enormous uncertainties that surround the function of banking and finance in the economy mean that it is foolhardy even for experts to venture confident judgments on what needs to be done; and it is foolish to require ordinary citizens to say what solution they propose. It is the task of policymakers, intellectuals and the industry itself to propose solutions that will meet people’s concerns.

It is imperative that the industry, in particular, begins to assume this responsibility. Banking is already well on its way to being seen as a parasite on the economy, as it has been many times in the past. The industry’s response to regulatory reform often sounds like a veiled threat – rein us in too much and we will stop lending and strangle the economy.

All that this attitude will accomplish is for the banking sector to be seen as an extortionist instead. That is hardly any better. With new rounds of bail-outs looming, bankers above all have much to gain from changing their tune.

In an analyst note, Bofa/ML Ethan S. Harris drops a bit of a bombshell prediction:

We expect a moderate slowdown in the beginning of next year, as two small policy shocks—another debt downgrade and fiscal tightening—hit the economy. The "not-so-super" Deficit Commission is very unlikely to come up with a credible deficit-reduction plan.

The committee is more divided than the overall Congress. Since the fall-back plan is sharp cuts in discretionary spending, the whole point of the Committee is to put taxes and entitlements on the table. However, all the Republican members have signed the Norquist "no taxes" pledge and with taxes off the table it is hard to imagine the liberal Democrats on the Committee agreeing to significant entitlement cuts.

The credit rating agencies have strongly suggested that further rating cuts are likely if Congress does not come up with a credible long-run plan. Hence, we expect at least one credit downgrade in late November or early December when the super Committee crashes.

This is quite a stunning prediction, mainly because nobody is talking about this. And though the experts were 100% wrong in thinking that a downgrade would increase borrowing costs, it did cause a major market jolt when it happened, leading to a major blow to confidence in August and September.

Another round of that would certainly not be helpful. Hense Harris' note is titled "Enjoy It While It Lasts". We have a nice little upswing in economic data, but next year could be rough again, when these confidence shocks hit.

As for the immediate term, Harris sees 2.7% GDP for Q3 (the advance estimate for which will be released this coming Thursday) and 2.3% GDP for Q4.

As Europe’s debt crisis has deepened, a recurring question is how much risk it poses to the United States economy, and especially American banks.

While American financial institutions have sought to limit any damage by reducing their loans and thus lowering their direct exposure to Europe’s problems, the recent rescue of the Belgian-French bank Dexia shows that there are indirect exposures that are less known and understood — and potentially worrisome.

Dexia’s problems are not entirely caused by Europe’s debt crisis, but some issues in its case are a matter of broader debate. Among them are how much of a bailout banks should get, and the size of the losses they should take on loans that governments cannot repay.

Among Dexia’s biggest trading partners are several large United States institutions, including Morgan Stanley and Goldman Sachs, according to two people with direct knowledge of the matter. To limit damage from Dexia’s collapse, the bailout fashioned by the French and Belgian governments may make these banks and other creditors whole — that is, paid in full for potentially tens of billions of euros they are owed. This would enable Dexia’s creditors and trading partners to avoid losses they might otherwise suffer without the taxpayer rescue.

Whether this sets a precedent if Europe needs to bail out other banks will be closely watched. The debate centers on how much of a burden taxpayers should bear to support banks that made ill-advised loans or trades.

Many on Wall Street and in government argue that rescues are essential, to avoid the risk of destabilizing the financial system — with one bank’s failure to pay its obligations leading to problems at other banks. But others counter that the rescue of Dexia is reminiscent of the United States’ decision to fully protect big banks that were the trading partners of the American International Group when it collapsed, a decision that was sharply questioned and examined by Congress.

Critics warn of a replay of the financial crisis in autumn 2008, when governments used taxpayer money to shore up troubled companies, then allowed them to transfer those funds to their trading partners to protect those institutions from losses. In using public money to rescue private institutions, these critics say, policy makers effectively rewarded banks that traded with companies that were in trouble, rather than penalizing them, and that encouraged risky behavior.

“The question is did the A.I.G. experience and the bailouts generally contribute to the current situation?” asked Jonathan Koppell, director of the School of Public Affairs at Arizona State University. Would the banks, he continued, “have had a different view in dealing with Greece — or with Dexia for that matter — if those who had dealt with A.I.G. hadn’t been made whole?”

Given the global and interconnected nature of the financial system, institutions around the world have other types of indirect risk to European debt problems. But the scope of these ties is not fully known, because the exposure is hidden by complex transactions that do not have to be reported in detail.

Dexia, which was bailed out by France and Belgium once before, in 2008, is just a small piece of the broader European debt and banking turmoil. But its collapse comes at a critical point, as European officials are meeting this weekend to work out how taxpayer money should be used to resolve the Continent’s debt crisis.

The most acrimonious debate has been over the amount of losses banks should suffer for lending hundreds of billions of euros to countries that may not be able to fully repay. In the case of Greece, big lenders in Europe have tentatively agreed to swallow modest losses on what they are owed, but are resisting proposals that would force them to take a much bigger hit. Even if they accept losses, they may then seek tens or hundreds of billions in capital infusions from their governments.

As the Dexia bailout deal closed last week and was approved by the French Parliament, officials overseeing the restructuring say that the bank will meet all of its obligations in full.

Alexandre Joly, the head of strategy, portfolios and market activities at Dexia, said in an interview that the idea of forcing Dexia’s trading partners to accept a discount on what they are owed “is a monstrous idea.” He added, “It is not compatible with rules governing the euro zone, and it has never, ever been considered to our knowledge by any government in charge of the supervision of the banks.”

While several government officials in France and Belgium agree that they expect to allow Dexia to use its rescue money to pay its trading partners in full, others said a final decision had not been made. Representatives for Dexia’s trading partners, like Morgan Stanley and Goldman Sachs, said they were not concerned about exposure to Dexia.

Dexia has suffered in several lines of business, including investments in sovereign debt from countries like Greece. But the biggest drain on its cash stemmed from a series of complex, wrong-way bets it made on interest rates related to its municipal lending business. A significant part of Dexia’s business is lending money to these localities at a fixed interest rate for relatively long periods, say 10 years. But, because the interest rate that the bank itself pays to finance its operations fluctuates, that exposes it to potential risk. If its cost of borrowing exceeds the interest it charges on loans outstanding, it loses money.

To protect itself, Dexia entered into transactions with other banks. But in doing so, it made a major miscalculation and protected itself only if interest rates rose. Instead, interest rates fell, and according to Dexia’s trade agreements, Dexia had to post billions of euros in collateral to institutions on the opposite side of its trades, like Commerzbank of Germany, Morgan Stanley and Goldman Sachs.

Dexia is also suffering losses on about 11 billion euros ($15.3 billion) in credit insurance it has written on mortgage-related securities, the same instruments that felled A.I.G., echoing that insurer’s troubles. In this business, too, Dexia’s problems have been worsened by aggressive demands by some trading partners for additional collateral. According to a person briefed on the transactions, Goldman Sachs, one of Dexia’s biggest trading partners, has asked for collateral equal to nearly twice the decline in market value of its deals. As was the case with A.I.G., Dexia must provide the collateral when the prices of the underlying securities fall, even if they have not defaulted.

In all, Dexia has had to post 43 billion euros to its trading partners to offset potential losses, up from 26 billion at the end of April and 15 billion at the end of 2008. The bank’s need for cash to meet these demands drained its coffers, and contributed to its need for a government bailout. The Belgian, French and Luxembourg governments provided a guarantee of up to 90 billion euros to Dexia, and Belgium purchased part of it outright.

Dexia declined to specify how much money had already gone to each trading partner. A Commerzbank spokesman declined to comment. Jeanmarie McFadden, a Morgan Stanley spokeswoman, said that the bank’s exposure to Dexia was immaterial and that Morgan Stanley had received adequate collateral to cover it. Lucas van Praag, a spokesman for Goldman, said “we have no reason to believe that Dexia will not continue to meet its contractual obligations after it is restructured.”

As for the aggressive collateral calls by Goldman, Mr. van Praag said: “Our dealings with Dexia have been perfectly normal. In an environment of widening credit spreads and increased volatility, collateral calls are to be expected.” The suggestion that Goldman has been more aggressive than Dexia’s other trading partners is “quite odd,” he said, adding: “If collateral is owed, we ask for it.” Mr. Joly of Dexia said the bank did not have “significant issues” with Goldman over collateral owed on some contracts.

Economists and financial players are closely watching how European officials handle Dexia’s financial contracts, which span the globe, to see what that might mean for other European banks that might need government support. As trading partners demand more cash, those demands could consume more of the money put up by the Belgian, French and Luxembourg governments.

“We know what the guarantees are that the government put down, but you don’t know how much the taxpayer will end up paying,” said Paul De Grauwe, a professor of economics at Katholieke Universiteit Leuven in Belgium. “I’m pretty sure there are other banks in Europe that have done similar things and may be caught in the crisis that is now brewing. I don’t think this is an isolated incident.”

It may be difficult for European governments to avoid making bank trading partners whole, especially American institutions, since the United States government paid full value to foreign banks that dealt with A.I.G. and also opened Federal Reserve programs to troubled foreign banks. Dexia, for example, leaned heavily on emergency lending programs created by the Fed during the depths of the financial crisis. At its peak borrowing near the end of 2008, Dexia received $58.5 billion from the Fed.

Some financial players may also argue that since France and Belgium took equity stakes in Dexia in 2008 — as part of the government bailout then — there was an implicit guarantee of the company’s obligations, similar to that of the housing finance giants Fannie Mae and Freddie Mac in the United States.

Walker F. Todd, a research fellow at the American Institute for Economic Research and a former official at the Federal Reserve Bank of Cleveland, said governments were setting a troubling precedent when they bailed out a company and paid its trading partners in full, as occurred with A.I.G. and as might occur with Dexia.

“In the short run, it would help if the authorities would say they refuse to provide publicly funded money for the payoffs of derivatives,” he said. “This is like using public funds to support your local casino. It is difficult to see how this is good for society in the long run.”

Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly. The idea would be to target any new efforts by the central bank at the parts of the economy that are most severely impeding a recovery—the housing and mortgage markets—by working to push down mortgage rates.

Lower mortgage rates, in turn, could encourage more home buying and mortgage-refinancing, and help the economy by freeing up cash for consumers to spend on other goods and services. Mortgage rates are already very low, but some Fed officials believe they might be pushed lower. Moreover, Fed officials believe their past purchase programs helped to lift stock markets, by driving investors from low-risk investments toward riskier investments.

The Fed discussions occur amid broader efforts in the government to find ways to revive housing markets and stir refinancing. "I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities," Federal Reserve governor Dan Tarullo said in a speech Thursday at Columbia University.

A new Fed mortgage-bond-buying program isn't a certainty. If inflation doesn't recede as many officials expect, or if the economy picks up with surprising vigor on its own, such a program might not win broad support inside the Fed. The most recent economic data have looked a touch stronger. In a report Thursday, for instance, the Labor Department said the number of people filing claims for unemployment insurance edged down last week.

The Fed next meets on Nov. 1 and Nov. 2. Any step toward mortgage purchases would surely face fierce opposition internally from Fed officials who believe the central bank has done all it can to revive the economy and should avoid new measures.

Three officials—Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Philadelphia Fed President Charles Plosser—dissented from central bank decisions on the two most recent easing steps, in part because of worries the measures could ultimately create too much inflation.

The Fed also faces political opposition—notably among Republicans—to more securities purchases, known by many as "quantitative easing." Texas Gov. Rick Perry in August said more Fed money-pumping before the election would be "almost…treasonous." But supporters of mortgage-bond purchases are emerging ahead of the November meeting to state their case.

In his speech Thursday, Mr. Tarullo argued that there was a need and "ample room" for additional measures by the Fed to spur more spending and investment, and that the risk of inflation is limited. And he said housing was where the Fed should direct its attention. "Housing continues to hang like an albatross around the necks of homeowners and the economy as a whole, with millions of underwater mortgages, a staggering inventory of foreclosed homes, and depressed levels of sales," he said.

Mr. Tarullo's comments are notable in part because he doesn't typically venture into discussions of the economy. Mr. Tarullo is a lawyer and has focused mostly on bank regulation in his tenure as one of five governors on the Fed's Washington based board, which he joined in early 2009 after being appointed by President Barack Obama. He has worked closely with Fed Chairman Ben Bernanke bank regulatory issues, but this was his first major policy address on the economy and it put him firmly in a camp of activists at the central bank who want the Fed to do more to spur growth.

This group has become more vocal in recent months. Others have spoken out favorably about mortgage purchases recently. In an interview with The Wall Street Journal Wednesday, Boston Fed President Eric Rosengren said mortgage purchases should be on the table if the Fed needs to act again. The risks to the economy, he added, "are still on the downside" and the economy might need more assistance from the Fed.

St. Louis Fed president James Bullard told reporters Thursday that the recent run of stronger-than-anticipated economic figures was "encouraging." But even though economic activity has picked up in the past several weeks, he added that a third round of quantitative easing is "still on the table" if conditions should worsen. Mr. Bullard hasn't always been a big supporter of easing moves.

Mr. Bernanke hasn't spoken out recently on mortgage purchases. In testimony to Congress earlier this month, he pointed to the housing sector as a driver of past recoveries that is missing this time. In August, he called broadly for "good, proactive" housing policies from the government.

From 2009 through March 2010, the Fed purchased $1.25 trillion worth of mortgage-backed securities in a program that Mr. Bernanke believes played an important role in healing distressed financial markets during the crisis. The Fed halted the program as it appeared the recovery was gathering steam.

At their meeting in September, Fed officials announced a modest shift in favor of mortgages. Until that meeting, the Fed had been trying to steer its overall $2.6 trillion securities portfolio away from mortgage debt and toward Treasury debt.

Some Fed officials believe the central bank shouldn't be favoring one sector of the economy—housing—over others, and thus shouldn't be in mortgage securities at all. In September, the Fed said it would halt its gradual move away from mortgages and instead would keep its holdings of mortgage-backed securities steady. The Fed holds $867 billion of mortgage backed securities and an additional $108 billion of the debt of government-owned mortgage giants Fannie Mae and Freddie Mac, which it is reinvesting in mortgage backed securities when it matures.

There are some practical reasons why a step toward mortgage purchases, if it happens, might not happen right away. In a parallel track to discussions about securities purchases, Mr. Bernanke is pushing the central bank toward more clearly and explicitly communicating to the public how the Fed reacts to changes in inflation and unemployment. It is a complicated debate that is unlikely to be resolved quickly. Officials might want to refrain from new bond-buying measures until that communication strategy is worked out.

But since their last meeting, many Fed officials have grown more alarmed about the persistence of high unemployment—9.1% in September—which Mr. Bernanke has termed a national emergency.

Fed Governor Betsy Duke and New York Fed officials have been focused on the troubles plaguing the mortgage market and looked for ways to make mortgage refinancing easier, particularly for the millions of "underwater" households whose debt is greater than the values of their homes.

Nearly 28 million outstanding mortgages have interest rates above 5.1% and are in theory ripe for refinancing, according to CoreLogic, a household-finance research firm. Many of them haven't been refinanced because of high fees and because homeowners have too little equity in their homes to qualify. It is possible that lower rates would help only borrowers who already have good credit, and not underwater homeowners.

Behind the scenes, some Fed officials have been urging the Obama administration and the regulator of Fannie Mae and Freddie Mac to find ways to reduce fees and other impediments that might be holding back refinancing, particularly for borrowers with impaired credit and underwater mortgages. The Fed has no control over such fees, but it can influence overall borrowing rates. Lower rates can help offset the fees, making refinancing worthwhile.

Mortgage rates haven't fallen as much as yields on U.S. government debt this year. Yields on 10-year Treasury notes have fallen from 3.34% at the beginning of the year to 2.16%, a 1.18 percentage point decline. Mortgage rates haven't fallen as much. Rates on 30-year mortgages, for example, have fallen from 4.77% to 4.11%, a 0.66 percentage point decline, according to Freddie Mac.

Other arguments in favor of the Fed holding mortgages could reemerge. When the Fed ramped up its mortgage program in 2009, for instance, some Fed officials preferred buying mortgages to buying Treasury debt because they wanted to avoid the perception that the central bank was helping the government fund large budget deficits. Moreover, some officials worry that the Fed already owns a large portfolio of Treasury securities—roughly $1.7 trillion—that it runs the risk of becoming too large a player in that broader market.

I find myself this morning hoping for the failure of the Federal Reserve. This implies that I’m also hoping for a collapse in the equity markets and a severe recession. Coupled with that, I want to see that the massive increase in money supply and the endless interventions of the Fed bring us a round of much higher inflation. I want the Fed to fail so miserably that they are marginalized for the next twenty years. I want Bernanke fired. I want the Fed disgraced.

I’m not rooting for this to happen because I’m short assets. I’m not hoping for more pain for Americans. I don’t want to see a collapse in the economy. And I certainly do not want to see more inflation. But I’m convinced that the only hope for the country is to shut this Fed down. For that to happen there must first be a collapse.

This morning we once again we have the mouthpiece of Bernanke, Jon Hilsenrath at the WSJ, telling us what is coming next from the Fed. This is disgusting in so many ways.

Hilsenrath got a call from Benny yesterday. This time Ben Boy tipped his hand. A new LSAP plan is in the works. This time it will be directed at the Agency MBS market (a la QE #1).

So we’re back to that old argument. Ben wants the S&P higher. He wants savers to do the heavy lifting by taking more and more equity risk. We have seen this plan again and again the past three years. It hasn’t worked. It won’t work this time either.

I’ll get what I want (chaos), but it will take some time. The new LSAP can’t happen till at least December. But sometime in the 1st Q it will be coming. In the past, articles like the one today in the WSJ lead to expectations of new Fed actions. This put a bid under equities. But as soon as the new monetary stimulus is announced the markets sell on the news. This time will be no different.

Core inflation is running at 2%. This is a level that Bernanke has repeatedly said he would respect when it come to more monetary gas. That he has initiated operation twist in the face of this inflation was the first evidence that he was abandoning his promise. In my book, Bernanke has flat out loud lied to the public on this. He should be fired for that.

CPI-U is a closer measure of actual inflation. That number is steaming along at 3.9%. We now have a situation where basic inflation is running at 8Xs the rate of short-term inflation. That ratio has never existed before in history.

Money supply is exploding over the past half year. Up over 30% (See Zero Hedge story). Inflation is the only possible outcome.

I’m not insensitive to the plight of the unemployed in America. There are some 20mm people who are either out of work or underemployed. I wish that something could be pulled out a hat and make that problem go away. But there is no magic solution. It’s time that Bernanke start to look at the other 280 million citizens that are paying the price for his actions. Ben is robbing savers. He is killing seniors who need predictable income (and should not be investing in risky equities). He is stealing from all of us with his push for more and more inflation as a cure to our problems.

I’m not happy with my position. I wish that I did not feel so strongly about this. But I’m convinced that the only thing that can actually help us out economically is that the Fed is completely marginalized. To have that happen there must be some big pain. Pain is exactly what we are going to get with Bernanke’s insane policies.

The new mantra of the Republican Party is the old mantra – regulation is a “job killer.” It is certainly possible to have regulations kill jobs, and when I was a financial regulator I was a leader in cutting away many dumb requirements. We have just experienced the epic ability of the anti-regulators to kill well over ten million jobs.

Why then is there not a single word from the new House leadership about investigations to determine how the anti-regulators did their damage? Why is there no plan to investigate the fields in which inadequate regulation most endangers jobs? While we’re at it, why not investigate the areas in which inadequate regulation allows firms to maim and kill. This column addresses only financial regulation.

Deregulation, desupervision, and de facto decriminalization (the three “des”) created the criminogenic environment that drove the modern U.S. financial crises. The three “des” were essential to create the epidemics of accounting control fraud that hyper-inflated the bubble that triggered the Great Recession. “Job killing” is a combination of two factors – increased job losses and decreased job creation. I’ll focus solely on private sector jobs – but the recession has also been devastating in terms of the loss of state and local governmental jobs.

From 1996-2000, for example, annual private sector gross job increases rose from roughly 14 million to 16 million while annual private sector gross job losses increased from 12 to 13 million. The annual net job increases in those years, therefore, rose from two million to three million. Over that five year period, the net increase in private sector jobs was over 10 million. One common rule of thumb is that the economy needs to produce an annual net increase of about 1.5 million jobs to employ new entrants to our workforce, so the growth rate in this era was large enough to make the unemployment and poverty rates fall significantly.

The Great Recession (which officially began in the third quarter of 2007) shows why the anti-regulators are the premier job killers in America. Annual private sector gross job losses rose from roughly 12.5 to a peak of 16 million and gross private sector job gains fell from approximately 13 to 10 million. As late as March 2010, after the official end of the Great Recession, the annualized net job loss in the private sector was approximately three million (that job loss has now turned around, but the increases are far too small).

Again, we need net gains of roughly 1.5 million jobs to accommodate new workers, so the total net job losses plus the loss of essential job growth was well over 10 million during the Great Recession. These numbers, again, do not include the large job losses of state and local government workers, the dramatic rise in underemployment, the sharp rise in far longer-term unemployment, and the salary/wage (and job satisfaction) losses that many workers had to take to find a new, typically inferior, job after they lost their job. It also ignores the rise in poverty, particularly the scandalous increase in children living in poverty.

The Great Recession was triggered by the collapse of the real estate bubble epidemic of mortgage fraud by lenders that hyper-inflated that bubble. That epidemic could not have happened without the appointment of anti-regulators to key leadership positions. The epidemic of mortgage fraud was centered in loans that the lending industry (behind closed doors) referred to as “liar’s” loans – so any regulatory leader who was not an anti-regulatory ideologue would (as we did in 1990-1990 during the first wave of liar’s loans in California) have ordered banks not to make these pervasively fraudulent loans.

One of the problems was the existence of a “regulatory black hole” – most of the nonprime loans were made by lenders not regulated by the federal government. That black hole, however, conceals two broader federal anti-regulatory problems. The federal regulators actively made the black hole more severe by preempting state efforts to protect the public from predatory and fraudulent loans. Greenspan and Bernanke are particularly culpable.

In addition to joining the jihad state regulation, the Fed had unique federal regulatory authority under HOEPA (enacted in 1994) to fill the black hole and regulate any housing lender (authority that Bernanke finally used, after liar’s loans had ended, in response to Congressional criticism). The Fed also had direct evidence of the frauds and abuses in nonprime lending because Congress mandated that the Fed hold hearings on predatory lending.

The S&L debacle, the Enron era frauds, and the current crisis were all driven by accounting control fraud. The three “des” are critical factors in creating the criminogenic environments that drive these epidemics of accounting control fraud. The regulators are the “cops on the beat” when it comes to stopping accounting control fraud. If they are made ineffective by the three “des” then cheaters gain a competitive advantage over honest firms. This makes markets perverse and causes recurrent crises.

From roughly 1999 to the present, three administrations have displayed hostility to vigorous regulation and have appointed regulatory leaders largely on the basis of their opposition to vigorous regulation. When these administrations occasionally blundered and appointed, or inherited, regulatory leaders that believed in regulating the administration attacked the regulators. In the financial regulatory sphere, recent examples include Arthur Levitt and William Donaldson (SEC), Brooksley Born (CFTC), and Sheila Bair (FDIC).

Similarly, the bankers used Congress to extort the Financial Accounting Standards Board (FASB) into trashing the accounting rules so that the banks no longer had to recognize their losses. The twin purposes of that bit of successful thuggery were to evade the mandate of the Prompt Corrective Action (PCA) law and to allow banks to pretend that they were solvent and profitable so that they could continue to pay enormous bonuses to their senior officials based on the fictional “income” and “net worth” produced by the scam accounting. (Not recognizing one’s losses increases dollar-for-dollar reported, but fictional, net worth and gross income.)

When members of Congress (mostly Democrats) sought to intimidate us into not taking enforcement actions against the fraudulent S&Ls we blew the whistle. Congress investigated Speaker Wright and the “Keating Five” in response. I testified in both investigations. Why is the new House leadership announcing its intent to give a free pass to the accounting control frauds, their political patrons, and the anti-regulators that created the criminogenic environment that hyper-inflated the financial bubble that triggered the Great Recession and caused such a loss of integrity?

The anti-regulators subverted the rule of law and allowed elite frauds to loot with impunity. Why isn’t the new House leadership investigating that disgrace as one of their top priorities? Why is the new House leadership so eager to repeat the job killing mistakes of taking the regulatory cops off their beat?

The benefits for BofA — and the possible risks to the federal government — in this transaction can be whittled down to two points that many people feel is unfair, because it sounds like another bailout:

1. BofA can save money. Due to the Moody's downgrade, the company will have to set up increased collateral payments or termination fees on contracts (estimated at up to an additional $3.3 billion in a regulatory filing). But shifting the derivatives to the higher rated retail branch may allow them to avoid that loss, Bloomberg columnist Jon Weil pointed out. In addition, BofA will be able to keep Merrill clients happy (they reportedly asked BofA to move the derivatives) and retain their business. Bloomberg reported that a large part of the push behind moving the derivatives came from "clients" and "partners" on their investment banking side.

2. Moving the derivatives to the commercial bank branch means the federal government will be backing the financial instruments. The Federal Deposit Insurance Corp. insures retail banks because it holds people's (taxpayer's) deposits. In the case that the bank collapses, the FDIC is allowed to borrow money from the Treasury to help run the bank and pay back its customers. Although the FDIC does not insure derivatives, Felix Salmon at Reuterspoints out the banks can use funds in its depository to pay off counterparties - and when there isn't enough, the FDIC will continue payments. That's effectively transferring responsbility from BofA's investment banks to the federal government - from private debt to public debt. (Although, would the really government allow BofA to collapse?)

Another caveat: The move has created a rift between the Federal Reserve and FDIC. BofA believes it has the right to move its derivatives without regulatory approval, according to Bloomberg. The bombshell in the Bloomberg exclusive was that the FDIC is against moving the derivatives — naturally because they do not want to be held responsible in the case the derivatives fail. The Fed, however, has indicated they support the measure, focusing their concerns on the fiscal health of the holding company.

And if the derivatives or bank do collapse, Weil surmises the taxpayers may have to bail them out again. Though the Dodd-Frank Act no longer allows bank bailouts — the FDIC has the power to use Treasury funds to run a government-seized bank. (That sounds a lot like a bailout.) The law stipulates that the banks will have to pay back the fees, but will a bank ever be able to pay back the costs to bail out a trillion-dollar company?

Of course, there are also reasons to remain calm and let the storm pass.

For one, putting derivatives into the commercial lending branch is something that all banks have done. As we noted before, the Fed granted Section 23A exemption to a lot of banks, and they used it. Derivative-holding giant J.P. Morgan has almost all its derivatives held in its retail operations. (Though some say J.P. Morgan's derivatives are regulated differently than BofA's.)

Another interesting thing that Weil points out is that most of BofA's derivatives are already in its retail side.

Overall, there are underlying questions here that challenge the complex system between the federal regulators fearful of another recession, the financial giants and an economic livelihood that hinges on the industry's survival.

Also, what the symbolic significance of the Fed's support for BofA means for the Volcker Rule — meant to separate the risk of investment banking from retail operations — is another interesting angle to ponder.

Standard & Poor's GlobalRatings team has updated its own European sovereign stress tests, and the results aren't pretty.

In fact, if Europe as a whole stops growing or if Spain and Italy need a bunch of help from the EU and IMF, everyone looks sunk.

Base-line scenario:

Their base-case scenario still assumes positive — though lackluster — growth in the eurozone of 1.0% to 1.5% over the next year. In this case...

- The IMF and the EU would be able to support 100% of Greece's, Portugal's, and Ireland's borrowing requirements. They would also be able to support up to 10% of Spain's and Italy's.

- They would not be able to support 30% of Italy and Spain's borrowing (along with 100% of PIG borrowing), however. In fact, they would be €287 billion ($398 billion) short.

- This scenario corresponds with S&P's current long-term ratings, under which Germany and France are both AAA, Spain is AA-, and Italy is A.

Double-dip scenario:

But if the eurozone sees a double-dip recession, then the prognosis looks much more grim. In this scenario, S&P subjects Italy, Spain, and Portugal to a "substantial" level of stress, Ireland, U.S., and Latin America to a moderate level of stress, everyone else — including Western Europe — to a "modest" level of stress:

- France, Spain, Italy, Ireland, and Portugal would all see sovereign downgrades of one to two notches.

- 20 out of 47 banks tested could fall below a 6% tier 1 capital to liabilities ratio. They would need about €78 billion ($108 billion) to be recapitalized to a 7% level.

- This would correspond with 60-85% of the Portuguese, Italian, Spanish, and Greek banking systems.

- The EU and IMF would not be able to provide adequate support under this scenario, which would probably equate to 100% of borrowing costs for Portugal, Ireland, and Greece, and up to 30% of borrowing for Spain and Italy.

Worst-case scenario:

But the team also analyzes an even worse scenario — not only do countries see a double-dip recession, they also see an interest rate shock:

- France, Spain, Italy, Ireland, and Portugal would all see sovereign downgrades of one to two notches.

- With higher popular angst, government willingness to adopt reforms could be inhibited. If that happened, more sovereigns (even than those listed above) could be downgraded.

- 21 out of the 47 banks tested would fall under a 6% capital requirement, and it would cost about €91 billion ($126 billion) to recapitalize them.

- This would correspond with 60-85% of the Portuguese, Italian, Spanish, and Greek banking systems.

- Short term borrowing costs could rise by 150-200 baisis points for many borrowers.

- There would be a shortfall of €287 billion ($398 billion) between the EU rescue funds' (EFSF and ESM) and IMF's joint lending capacity and the amount of funding needed to support the PIIGS. That amounts to 2.7% of aggregate GDP for eurozone member states.

In both scenarios, S&P expects government borrowing to skyrocket as budget deficits and bank recapitalizations "balloon."

In sum, the IMF and EU are incapable (at least in their current capacities) of maintaining a firewall around Italy and Spain in all but the best-case scenario.

Of course, S&P has promised to revise these projections based on the outcome of upcoming EU summits.

Their conclusion is terribly ominous (emphasis added):

Although our [adverse] scenarios take into account various debatable assumptions, we believe that they illustrate the likely general direction under given conditions. Beyond the likely downgrade of a number of sovereigns if such events came to pass, our scenarios suggest that current support mechanisms may not be sufficient if conditions deteriorate beyond current expectations.

Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.

The dire analysis, contained in a "strictly confidential" report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.

Under a more severe test run by economists for the so-called "troika" of lenders – the IMF, European Central Bank and European Commission – Greece’s bail-out needs could balloon to €444bn, the study said.

The report also made clear European leaders are considering "haircuts" on Greek bonds far higher than previously known. The study determined that in order to bring a second Greek bail-out back to the €109bn agreed in July, bondholders would have to take a 60 per cent loss on their current holding.

That is significantly more than the 21 per cent haircut agreed in a deal with private investors three months ago. The analysis says that a 50 per cent haircut, increasingly considered the most likely scenario among European policymakers, would put the second Greek bail-out at €114bn, or €5bn more than the July deal. "Recent developments call for a reassessment," the report said. "The situation in Greece has taken a turn for the worse."

The debt analysis report was only distributed to national capitals on Friday afternoon, just hours before finance ministers for the 17 eurozone countries arrived in Brussels for a deliberation over Greece that lasted late into the night.

European officials said the delay was due, in part, because of a disagreement between the IMF and the ECB over whether Greece could meet its debt obligations without significant writedowns. The IMF argued that Greek bondholders needed to take larger hits, while the ECB has repeatedly warned that such defaults could spread market panic.

In a clear reference to that dispute, a footnote said the ECB "does not agree with the inclusion" of the report’s haircut scenarios. In order to deal with the possible market panic from such large haircuts, eurozone leaders have agreed to increase the firepower of its €440bn rescue fund.

Eurozone leaders had hoped to finalise an agreement on a second Greek bail-out at a highly-anticipated summit on Sunday. But disagreements between France and Germany over how to increase the fund’s wherewithal have forced them to put off a decision until a second summit, which will now be held on Wednesday.

Despite the deteriorating picture painted by the official analysis, eurozone finance ministers approved its €5.8bn portion of the next €8bn tranche of bail-out aid, an agreement that came a day after the Greek parliament yet again passed new austerity measures amidst some of the most violent street protests in over a year.

The deterioration in Greece’s financial situation described in the troika’s debt analysis report is deep and across the board, and Greece is likely to be forced to rely on bail-out loans to finance its operations through at least 2021.

The much-touted Greek privatisation programme, which was expected to bring as much as €66bn in cash to help pay down debt, is now expected to bring in €20bn less, and lenders are now assuming that the Greek government will continue to lag in implementing repeatedly-promised austerity measures.

"In keeping with experience to date under the programme, it is assumed that Greece takes longer to implement structural reforms, and that a longer timeframe is necessary for them to yield macroeconomic dividends," the report said. "A longer and more severe recession is thus assumed."

The French stock market regulator has advised French banks to take bigger losses on their holdings of Greek government bonds, arguing that the relatively small writedowns announced in recent months were now seen as insufficient.

The Autorité des Marchés Financiers has written to financial institutions to tell them to reassess their decision to value Greek sovereign debt in line with the terms of the Greek bail-out agreed in July, the Financial Times has learned.

Controversially, the 21 per cent "haircut" envisaged for private sector bondholders as part of the rescue package had been used as a benchmark for losses by various French banks and some insurers when they reported their results for the first half of 2011.

In sharp contrast, some rivals in other countries – such as the UK and Germany – had recognised much heavier losses of about 50 per cent on their "available for sale" Greek government bonds, in line with distressed market prices.

The AMF confirmed that it had sent the letters, without releasing a copy. It said the letters had argued that the July bail-out was "jeopardised" and that the 21 per cent haircut was "now perceived as insufficient".

Greek sovereign bondholders reopened negotiations with the European authorities in recent weeks, with bankers saying a revised haircut was likely to be in a range of 30-40 per cent. However, analysis for international lenders seen by the Financial Times on Friday put the figure as high as 60 per cent.

The issue of so-called "private sector involvement" in a voluntary restructuring of Greek sovereign debt will be a central topic of discussion in this weekend’s talks between European leaders over the measures needed to address the deepening eurozone crisis.

The AMF said it had not specified how big a loss it recommended companies should take in their third quarter results: "Management is primarily responsible for this assessment, rather than the securities regulator."

Meanwhile, the Banque de France, the French central bank, declined to comment on reports from senior European accountants that it had also written to French financial institutions on the subject of Greek writedowns.

French banks have more cross-border exposure to Greece than any other country, mainly through subsidiaries owned by Crédit Agricole and Société Générale. BNP Paribas holds the most Greek sovereign bonds among private sector investors, with €4bn of exposure.

Unlike Axa, the French insurer that took a 40 per cent haircut on its holding of Greek government bonds at its half year results, the French banks argued that limiting themselves to 21 per cent was justified because trading in Greek government debt was so subdued, making market prices unreliable.

However, this reasoning was challenged by Hans Hoogervorst, chairman of the International Accounting Standards Board, the accounting rule-setter. The inconsistency also raised eyebrows in the US, which is considering whether to adopt the accounting rules used in the European Union.

Following their less aggressive approach to Greek sovereign debt writedowns, shares in French banks suffered in August when fears about eurozone debt contagion among peripheral countries escalated.

Many analysts expect the banks to take a bigger haircut when they report their third-quarter earnings next month. BNP Paribas has already said that a 55 per cent impairment would lead to a provisioning of €1.7bn, on top of the €534m taken at the end of the first half.

FT Alphaville has also taken a look at “Greece: Debt Sustainability Analysis”, an assessment prepared by European Commission economists for discussion on Friday among European finance ministers. We’ve put it in the usual place (and extensively quoted excerpts below).

The headline: it suggests private bondholders will be pushed to take 50 or 60 per cent haircuts.

From the report’s summary:

Greece: Debt Sustainability Analysis October 21, 2011

Since the fourth review, the situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform driven increases in productivity. The authorities have also struggled to meet their policy commitments against these headwinds. For the purpose of the debt sustainability assessment, a revised baseline has been specified, which takes into account the implications of these developments for future growth and for likely policy outcomes. It has been extended through 2030 to fully capture long term growth dynamics, and possible financing implications.

The assessment shows that debt will remain high for the entire forecast horizon. While it would decline at a slow rate given heavy official support at low interest rates (through the EFSF as agreed at the July 21 Summit), this trajectory is not robust to a range of shocks. Making debt sustainable will require an ambitious combination of official support and private sector involvement (PSI). Even with much stronger PSI, large official sector support would be needed for an extended period. In this sense, ultimately sustainability depends on the strength of the official sector commitment to Greece.

Here are the starting assumptions made by the report’s authors:

A slower recovery. In keeping with experience to date under the program, it is assumed that Greece takes longer to implement structural reforms, and that a longer timeframe is necessary for them to yield macroeconomic dividends (e.g. due to complementarities). A longer and more severe recession is thus assumed, with output contracting by 5? percent in 2011, and by 3 percent in 2012. Growth then averages about 1? percent per year in 2013-14, 2? percent in 2015-20 (as a cyclical rebound kicks in, and structural reforms start to pay off); and 1? percent per year in 2021-30 (as the economy reverts to potential growth, which is constrained by demographic trends). All told, real output growth is projected to be cumulatively 7? percent lower through 2020, versus the projections made at the time of the 4th Review.

Lower privatization proceeds. Given the adverse market conditions and technical constraints faced by Greece, a more conservative but still suitably ambitious path is assumed for privatization proceeds for the purpose of the debt sustainability analysis. Receipts rise from 1? percent of GDP in 2012 to 2 percent of GDP for the period 2013-14, and peak at 2? percent of GDP during 2015-17. They fall back at 2 percent of GDP per year for 2018-20. Through 2020, total privatization proceeds would amount to €46 billion, instead of the €66 billion assumed in the program (i.e. the original target of €50 billion plus an additional amount reflecting the fact that bank recapitalization will likely create additional assets to be disposed of).

Reduced fiscal adjustment needs. The nominal fiscal targets are maintained through the program (mid-2013) and after that, the primary surplus is assumed to improve further until it reaches 4? percent of GDP for the period 2014-16. The primary surplus steps down to 4? percent of GDP in 2017-20 and to 4 percent of GDP in 2021-25 (a level which in the past Greece has been able to sustain). Since few countries have been able to sustain a 4 percent primary surplus, it is assumed that from 2026 onwards, the primary surplus is maintained at 3? percent of GDP. Under this path, which requires sustained and unwavering commitment to fiscal prudence by the Greek authorities, the overall fiscal balance would not drop below 3 percent of GDP until 2020.

Delayed access to market financing. The PSI agreed at the July 21 Summit is assumed to be put into place. The issue of when market financing will be restored is inherently uncertain. For the purposes of this analysis, new market financing is assumed to become available only once Greece has achieved 3 years of growth, three years of primary surpluses above the debt stabilizing level, and once debt drops below 150 percent of GDP. This is admittedly an arbitrary rule, and is used for illustrative purposes to give an indication of the scale of official support that could be needed to fill any financing gap until market access is restored in 2021.

All of the above leads them to conclude, of course, that the status quo is unsustainable:

Under these assumptions, Greece’s debt peaks at very high levels and would decline at a very slow rate pointing to the need for further debt relief to ensure sustainability. Debt (net of collateral required for PSI) would peak at 186 percent of GDP in 2013 and decline only to 152 percent of GDP by end-2020 and to 130 percent of GDP by end-2030. The financing package agreed on July 21(especially lower rates on EFSF loans) does help the debt trajectory, but its impact is more than offset by the revised macro and policy framework. Greece would not return to the market until 2021 under the market access assumptions used, and cumulatively official additional financing needs (beyond what remains in the present program, and including the eventual rollover of existing official loans) could amount to some €252 billion from the present through to 2020.

The report then goes on to assess several “shocks” that could further blow the trajectory off-course. Given all these, it concludes:

Making Greek debt sustainable requires an appropriate combination of new official support on generous terms and additional debt relief from private creditors: · Large, long-term, and sufficiently generous official support will be necessary for Greece to remain current on its debt service payments and to facilitate a declining debt trajectory. The commitments given at the July 21 Summit—that euro area partners would continue to support countries under adjustment programs, like Greece, for as long as it takes to regain market access (provided the program is implemented) —represent an important breakthrough, and the credibility of this commitment is critical to a sustainable Greek debt position. The revised baseline does indeed rely on additional official support beyond the amounts tabled during the July 21 Summit, to give the Greek government time to adjust until market access is successfully restored. As noted, the precise timing of market re-access is inherently uncertain. Under the assumptions used, the time required to get back to market could be significant, generating a potential need for additional official financing ranging up to €440 billion (i.e. under the worst case of the scenarios studied here, the faster macro adjustment shock).

And this, which is perhaps the killer paragraph. It assess how far 50 and 60 per cent haircuts on PSI would take you (our emphasis):

Deeper PSI, which is now being contemplated, also has a vital role in establishing the sustainability of Greece’s debt1. To assess the potential magnitude of improvements in the debt trajectory, and potential implications for official financing, illustrative scenarios can be considered using discount bonds with an assumed yield of 6 percent and no collateral. The results show that debt can be brought to just above120 percent of GDP by end-2020 if 50 percent discounts are applied. Given still-delayed market access, large scale additional official financing requirements would remain, estimated at some €114 billion (under the market access assumptions used). To get the debt down further would require a larger private sector contribution (for instance, to reduce debt below 110 percent of GDP by 2020 would require a face value reduction of at least 60 percent and/or more concessional official sector financing terms). Additional official financing requirements could be reduced to an estimated €109 billion in this instance. Of course, it must be noted that the estimated costs to the official sector exclude any contagion-related costs.

All in all, the report is a depressingly realistic analysis of Greece’s predicament; anyone who thinks it can grow its way out of its current problems is talking out of their high-hat. The report suggests that even with a 50 per cent haircut by private bondholders, Greece will require further and sustained support by public international lenders.

Depressing, sure — but also necessary and achievable, though it’ll still take more than what’s in this document.

For what the report doesn’t seem to cover is — unsurpisingly — the role of official creditors. As UBS economists noted earlier this week, even 50 or 60 per cent haircuts won’t be enough. A 110-120 per cent debt to GDP by 2020 (as suggested in the scenario) remains highly dangerous.

Indeed, there appears to be concern, to put it lightly, at the ECB about the scenarios used in the report. Scenarios that get a little close to home, perhaps. Here’s an interesting footnote to the last quoted paragraph:

The ECB does not agree with the inclusion of these illustrative scenarios concerning a deeper PSI in this report.

Because, as FT Alphaville’s Joseph Cotterill adds in an email to us, “either the official creditors take haircuts too (ha!) OR they’ll be discussing 90-100 per cent private haircuts soon enough.”

Chancellor Angela Merkel took aim at Italy as typifying profligate government, saying the resolution of Europe’s crisis will only emerge if countries slash their debt and live within their means.

Italy’s outstanding debt at 120 percent of gross domestic product can’t be blamed on speculators, Merkel told a group of women in her Christian Democratic Union today. Markets demand higher interest rates on Italian bonds because the level of such debt is “seen very critically,” she said.

“We want to and we must defend the euro -- and we will -- but not to the extent that we forget what the source of the crisis is,” Merkel said in a speech in the western German city of Wiesbaden before heading to Brussels to tackle the crisis.

European leaders are converging on the Belgian capital in an attempt to narrow differences on how to address the crisis that threatens to spiral out of control. Merkel’s swipe at Prime Minister Silvio Berlusconi’s government also comes a month after the Italian leader was caught on a wiretap making denigrating comments about the chancellor.

Merkel and Berlusconi may meet in Brussels at a gathering of leaders aligned with the European People’s Party before heads of state and government gather tomorrow.

Even as President Barack Obama calls on European leaders to lay aside their differences, Merkel took the U.S. government to task for failing to manage its own debt. “It doesn’t look much better in America, even if the markets aren’t quite concentrating on that,” Merkel said today.

Merkel also reiterated her objection to jointly issued euro bonds, saying that while such an arrangement could act initially as a salve to markets, common borrowing would lead to “solidarity in mediocrity.”

“This will be the message for the coming years,” Merkel said. “It will be very, very hard -- our task is no longer to live beyond our means. That goes for Germany and for every other European country.”

The 'bailout' offered to the Greeks will have seen its economy contract 15% by the end of next year – a chilling illustration of what happens to economies starved of growth

So Wednesday is the new Sunday: the make-or-break European summit scheduled for today will spill over into next week, with Wednesday now mooted as the final, final deadline for reaching an agreement.

Certainly, Merkel, Sarkozy and the rest won't want to face their exasperated counterparts from the US, China and Japan at the G20 meeting in Cannes in 12 days' time without being able to show that they have heeded the world's pleas for them to get their act together and, as US treasury secretary Tim Geithner put it, "take the threat of cascading default, bank runs and catastrophic risk off the table".

If they can overcome their differences, the final "comprehensive" package looks likely to have the three elements demanded by financial markets and by Geithner: a substantial debt writedown for Greece's private sector investors, many of them French and German banks; a recapitalisation of the banking sector to patch up the hole blown by the crisis; and a beefed-up European financial stability facility, the so-called "big bazooka".

That should buy some time, helping to prevent a Greek partial default setting off a domino effect in the world's financial markets that could bring Italy, Spain and even France crashing down.

The writedown on privately held Greek bonds, if it's large enough and successfully executed, could also mark a small step towards long-term debt sustainability for the Greeks, by finally reducing the total amount they owe. The 21% "haircut" proposed in the last emergency rescue deal, in July, was almost immediately deemed too small.

Yet even if the French and Germans can do a deal and bring their eurozone colleagues along with them, there remains a deep hole in the logic driving the entire round of frantic negotiations. The EFSF – the big bazooka – is aimed at protecting embattled countries during temporary crises by buying up their bonds when the markets have driven up interest rates to eye-watering levels.

But that does nothing to reduce the overall level of borrowing: the debt burden of the countries that are forced into the EFSF's hands will continue to rise. That will make it all the more important that the affected countries – Portugal, and possibly Spain and Italy – are able to grow their way out of trouble; but that seems increasingly impossible in the current climate.

Economic growth is the missing piece of the euro jigsaw. There is nothing in the plan being thrashed out in Brussels that can prevent the eurozone sliding into the double-dip recession that now looks all but inevitable, or help the hardest-hit countries to expand again. The only answer being articulated is German-style austerity: and that recipe hasn't worked well so far.

While the diplomatic face-off between Paris and Berlin was going on last week, a stunning fact emerged about the country at the centre of the crisis. According to Brussels, the ECB and the IMF, it is now expected that the Greek economy will have contracted by 15% between the onset of the crisis and the end of next year.

That's not a recession: it's economic Armageddon. Greece's debt-to-GDP ratio is now expected to balloon to 181%, against the 161% predicted in July: in other words, the problem the drastic spending cuts were meant to solve has got far worse, not better.

Unemployment is at 16.5%; businesses are failing; civil servants have faced deep pay cuts; public services are being slashed. Far from being "rescued" or "bailed out" by its eurozone neighbours, Greece has been plunged ever deeper into the worst economic crisis in living memory, and it should be no surprise that protesters have taken to the streets.

Helping recession-gripped countries to borrow more, as the EFSF will do, is essential to preventing them sliding into bankruptcy, but it does nothing to solve the underlying problem – and nothing to tackle the diverging fortunes of the 17 economies within the single currency zone, which are stretching it to breaking point.

A substantial write-off of Greece's debts, as envisaged under the deal being hammered out in Brussels, will help if it comes off; but the advice to almost any other country in such a deep rut – saddled with uncompetitive firms and a creaking tax system, and trapped in recession – would be a sharp devaluation to buy some competitiveness and hopefully kickstart growth. Without such a devaluation, Greece will need substantial economic aid – not yet more loans – to rebuild its shattered economy, and there's little sign of that materialising.

It would help if Greece's major export markets weren't all on their own self-imposed austerity drive at the same time; but France, Italy and Spain all announced new cutbacks over the summer to satisfy the bond markets' demands for fiscal self-flagellation.

At each cuts announcement, the experts marked down that country's growth forecasts. Many are now expecting the entire eurozone economy to contract in the fourth quarter of the year. There is a clear risk that forcing the banks to recapitalise could exacerbate the situation yet further, by depressing lending.

Sir Mervyn King stressed in his speech in Liverpool last week that the crisis facing the single currency has never been about liquidity – a short-term cash flow problem. Instead, it's about solvency, and it runs much wider than Greece.

The draft agreement that was circulating last week included an insistence that Greece's situation was unique, and that no other euro member would be allowed to follow it into default. But few expect Greece to be the last; and as its experience shows, being "bailed out" by the eurozone can be economically and politically devastating.

Erik Britten of Fathom Consulting puts it this way: "The term bailout is used in a number of ways. One of them is allowing a country to finance their deficits without borrowing from the markets, and their debt-to-GDP ratio continues to go up. The other kind of bailout is one that says 'we accept that we have lost the money that we lent you: we're writing off that debt'."

That's what campaigners against the insufferable burden of developing country debt used to call a "jubilee" – but it's not exactly what Angela Merkel has in mind.

Germany, which will ultimately pick up the tab, is understandably determined that there must be a heavy price attached to fiscal failure. But Greece's plight reveals the catastrophic consequences of tackling a debt crisis by handing out more loans while systematically slashing away at the economy's productive potential.

More conspiracy-minded analysts of the machinations in Brussels believe that Sarkozy and Merkel are merely hoping to paper over the cracks until 2013, when the permanent European stability mechanism comes into force. That will bring with it a formal process for sovereign debt default and, potentially, for punishing countries that break the rules, perhaps by forcing them to leave – "the big red ejector button" as one eurosceptic City veteran called it last week.

At that point, Greece, and any other countries still failing to make the grade, could be elbowed out, leaving a smaller "hard euro" area centred on Germany. That may be much too cynical; but there's a serious risk that the current approach, bazookas and all, locks Europe into decline. No wonder battle-scarred Tokyo executives, watching the unfolding crisis from afar, told my colleague Dan Milmo last week that Europe may be condemning itself to a Japanese-style "lost decade".

Finance ministers from the eurozone countries are discussing the idea in order to boost the lending capacity of the EFSF

The EU could tap sovereign wealth funds from Asia and the Gulf in order to boost the financial clout of its main vehicle to bailout eurozone countries suffering debt distress and prevent contagion spreading, it is understood.

Finance ministers from the 17 eurozone countries are discussing the option of creating a "special purpose vehicle" for the European Financial Stability Facility (EFSF) in order to boost its current €440bn (£383bn) lending capacity.

The idea, according to sources, would be to attract further money from official and private investors, with the sovereign wealth funds of countries such as China, Singapore or Qatar a prime target. Some of these already invest in European banks such as Barclays and UBS.

The only other option now being discussed is to turn the EFSF into an insurer that would offer to insure the first, perhaps 20%, of losses on new government debt held by private creditors such as banks.

These creditors are now locked in negotiations with senior eurozone officials over the scale of the losses they will have to suffer because of Greece's deteriorating debts. In July they volunteered to accept 21% but Jean-Claude Juncker, eurogroup chairman, now says: "We have agreed that we have to have a significant increase in the banks' contribution."

A "strictly confidential" report from Greece's "troika" of debt inspectors warns that the banks will have to accept 60% losses or "haircuts" if governments were to limit their second bailout to €109bn. It says Greece could require €252bn in support between now and the end of 2020 and, in a worst case scenario, this could rise to almost €450bn.

Meanwhile Silvio Berlusconi faces condemnation for his handling of Italy's economic problems when Europe's main Christian Democrat leaders hold their strategy talks ahead of Sunday's two summits, one for all leaders of the EU's 27 member states and another just for the 17 eurozone countries.

Nicolas Sarkozy is especially incensed by the Italian prime minister as French banks are heavily exposed to Italian bonds if, by any chance, serious contagion spreads from Athens to Rome. The French president is also set to resume his cooling relationship with German chancellor Angela Merkel as the two plot to make the real decisions, in a private meeting today, about how to save the euro.

European leaders were struggling on Friday to craft a bolder solution to the region’s financial crisis, despite clear signals from French and German officials that they have sharp differences heading into an important weekend summit meeting in Brussels.

As ever, the focus is on Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France, who have made a habit of cobbling together deals to present to their European Union colleagues. But forging an agreement now is harder than before, as Paris and Berlin face core differences over how to maximize the euro zone’s financial rescue fund and how far the European Central Bank should intervene in the bond markets, either on its own or through the bailout fund.

Already the two leaders have announced that Sunday’s summit meeting, which had already been delayed to allow more time for negotiations, would be followed by another summit meeting as early as Wednesday. That announcement, paradoxically, seemed to buoy stock and bond markets, apparently because the Europeans at least appeared to be focusing intensely on resolving the crisis.

But the delay may have been because Mr. Sarkozy needs pressure from other nations to bring Mrs. Merkel around to a more flexible position on how to use the bailout fund, called the European Financial Stability Facility, and the central bank.

Mr. Sarkozy has now rushed twice to Germany for talks with Mrs. Merkel, the last time on Wednesday, as his wife was giving birth, to press for a deal. The meeting was testy, said German officials, who have complained that France is "not budging an inch." Mr. Sarkozy, clearly the supplicant in the relationship, speaks openly of a "European rendezvous with history," while Mrs. Merkel keeps repeating that "there is no magic wand" and that a long-term solution will take time.

Jean-Claude Juncker, who also leads the meetings of euro zone finance ministers, said that Thursday’s move to delay final decisions until the second summit meeting Wednesday looked "disastrous" to the outside world. He canceled a news conference scheduled for after Friday’s meeting of the finance ministers of the 17 countries that use the euro, suggesting that no breakthrough was imminent.

The "Franco-German couple" has been vital to each of the agreements reached by the European Union during this two-year crisis. But so far none of the deals have been sufficient to solve even the problem of Greek indebtedness, which is growing worse in an austerity-driven recession, let alone the problem of contagion spreading now to Italy and Spain.

Nor has there been an agreement yet on how much capital needs to be injected into European banks so that they can reassure investors that they will remain solvent even as the sovereign debt of Greece, Italy, Spain and other hard-hit countries loses value.

These are the main issues on the agenda. On Greece, Germany appears willing for a deal to restructure Greek debt to no more than half of its face value, to try to bring Greece’s debt burden to a sustainable level. But Germany wants private investors and banks to accept such losses voluntarily to avoid a formal default, which would be a first for the euro zone.

Big European banks had already agreed to what was billed as a 21 percent reduction in the value of their Greek debt in July, a deal not yet implemented, and they are reluctant to reopen the matter. Nor are they confident that enough private bondholders would agree to such a large cut.

France and the European Central Bank do not want to restructure Greek debt further, fearing market contagion and, for Paris, additional pressure on French banks that hold significant amounts of Greek, Spanish and Italian debt. A major recapitalization of French banks would put more strain on France’s budget and require new cuts elsewhere to meet deficit targets, and could thus jeopardize France’s coveted AAA credit rating. That would be bad politics with elections six months away and Mr. Sarkozy already unpopular.

There is also a fear that banks would cut back on lending rather than try to raise more capital while their stock prices are down, which could lead to a new credit crunch at a time when the entire euro zone is on the brink of a new recession.

France wants Europe to collaborate on recapitalizing banks, ideally by turning the bailout fund into a bank, which could then draw on loans from the European Central Bank, which has the authority to print euros as needed. But Germany and the central bank itself have resisted that option. "The path is closed for using the E.C.B. to ease liquidity problems," Mrs. Merkel told her parliamentary caucus in Berlin on Friday, Reuters reported.

Mrs. Merkel wants each country to be responsible for injecting funds into its own banks, and only then turn to the regional bailout fund in an emergency. Politically, it is easier for her to explain to Germans that German money is being used to recapitalize German banks than to concede that it is going to everybody’s banks. Mrs. Merkel is also compelled by German law to seek a mandate from Parliament’s budget committee before committing new funds. Mr. Sarkozy does not face such restrictions.

Still, some progress has been made on the amount of new funds needed to shore up banks. Partly that is because the Europeans have decided that the amount required is half of what the International Monetary Fund and some other experts have suggested. And partly because European officials have used new ways of valuing sovereign debt that offset markdowns on the bonds of weaker countries with paper gains on sovereign holdings of less indebted countries.

Even so, France is asking for a period of nine months for banks to meet recapitalization targets. France and Germany also disagree on how to leverage or maximize the $590 billion bailout fund to create a "wall of money" to discourage the markets from speculating further on Spain and Italy. The fund has already committed about $200 billion to Greece, Portugal and Ireland, and the German government has promised taxpayers that its own share, as the largest contributor, will not be more than $305 billion.

There are a variety of ideas on how to leverage the fund, but so far they have run into problems with existing treaties, and the European Central Bank has opposed the idea that it should guarantee loans made by the fund. Germany has discussed using the fund as "insurance" to guarantee a portion of any potential losses on future bond auctions for Italy and Spain, but France would still prefer that the bailout fund be allowed to borrow from the central bank. France might agree to the German idea if the insurance ratio is higher.

And there are reports that the International Monetary Fund might also provide some cheaper credit to European countries facing severe market pressure on their bonds. The Europeans will also be discussing longer-term measures to provide more "economic governance" to the euro zone nations, but those changes are also likely to require treaty changes.

While the markets are focused on Brussels on Sunday and Wednesday, a firmer deadline is probably Nov. 3-4, when Mr. Sarkozy presides over the meeting of the Group of 20 leading economies in Cannes. President Obama, who has been in regular contact by telephone with Mr. Sarkozy and Mrs. Merkel, wants a solution by then, at least, to stop the drag the crisis is having on global markets, economic growth and his own prospects for re-election.

European finance ministers are considering setting up a fund to entice outside investors to buy troubled euro-area government bonds, as they struggled over how to tame the Greece-fueled debt crisis, said a person familiar with the matter. The investment vehicle was one of two options being weighed, along with using the European Financial Stability Facility to boost the rescue firepower from 440 billion euros ($611 billion) currently, the person said.

"The principle that we leverage the EFSF with private money is being subscribed by everyone, but the level of success is uncertain," Dutch Finance Minister Jan Kees de Jager told reporters on the second day of crisis talks in Brussels. "How much can we raise, that is being looked at."

Europe’s room for maneuver narrowed yesterday with a report that Greece’s economy is deteriorating, piling on pressure to build a stronger anti-crisis firewall by a self-imposed Oct. 26 deadline. Measures being considered include a boost in bailout funds to 940 billion euros, deeper writedowns on Greek debt, and a demand that banks increase Tier 1 capital to 9 percent by mid-2012.

Stocks and the euro rallied yesterday on signs that warnings from global leaders including President Barack Obama have jolted European policy makers into action. European Union office buildings, luxury hotels and a suburban Brussels flower park were the scenes today for a crisis-management convention involving national and EU-level leaders, finance ministers, central and commercial bankers and their aides.

Bank RecapitalizationAll 27 EU finance ministers discussed bank recapitalizations in the morning, followed by the second session in two days of the 17 ministers from euro countries. Neither session yielded a formal announcement.

German Chancellor Angela Merkel and French President Nicolas Sarkozy meet privately in early evening before a later sitdown with European Central Bank President Jean-Claude Trichet, EU President Herman Van Rompuy, European Commission President Jose Barroso and EU Economic and Monetary Affairs Commissioner Olli Rehn. International Monetary Fund Managing Director Christine Lagarde will also be there.

The special purpose investment vehicle, the newest option on the table, would buy bonds in the primary and secondary markets, the person said. The purpose would be to attract outside investors and sovereign wealth funds, tapping reserves built up by countries like China.

EFSF GuaranteesA special-purpose vehicle was also discussed at this month’s meeting of the Group of 20 finance ministers and central bankers to be run by the IMF as a way to channel loans from countries such as China and Brazil. "To be able to do this we’d have to create a special purpose vehicle, which we have done in the past in other circumstances," Antonio Borges, the IMF’s European department head, said Oct. 5. "It could be done, it’s not to be excluded."

The other option also involves EFSF first-loss guarantees, yet without creating the special fund. It was backed by Germany and was the front-running option until this week, when France complained that it wouldn’t be enough and sought to turn the fund into a bank that could borrow from the ECB.

Aid of 256 billion euros for Greece, Ireland and Portugal has failed to stabilize markets or prevent the turmoil from spreading to France, co-anchor with Germany of the European economy. French bank shares have tumbled on concern they are vulnerable to losses around Europe’s periphery. France’s climbdown was signaled late yesterday by Finance Minister Francois Baroin. Tapping the central bank "is not a definitive point of discussion for us," he said. "What matters is what works."

ECB OppositionYesterday’s start of the six-day summit marathon was overshadowed by the report by the EU Commission, ECB and IMF on Greece that highlighted the dilemmas of righting Greece’s finances without sending shockwaves through the banking system.

Divisions over the handling of Greece were thrown into relief by the report, which was obtained by Bloomberg News. It contained a footnote that the ECB, which has lobbied against writedowns, "does not agree" with the inclusion of the bond- loss scenarios.

Officials are considering five scenarios to update a July agreement that foresaw 21 percent losses on Greek debt for private bondholders, people familiar with the deliberations said. They range from sticking with a voluntary swap to a so- called hard restructuring that forces investors to exchange Greek bonds for new ones at 50 percent of their value, the people said.

A deepening recession and delays in enacting budget cuts have raised Greece’s financing needs by at least 20 billion euros since July, when euro leaders hammered out a 159 billion- euro package, the people said. "We have to discuss with the private sector and see what is suitable," Spanish Economy Minister Elena Salgado told reporters. Ministers discussed investor losses of "more than 21 percent," she said.

The ministers yesterday signed off on the payout of its 5.8 billion-euro share of an 8 billion-euro loan to Greece. It’s the sixth installment of a 110 billion-euro package awarded in May 2010.

A report by Greece's international creditors on the country's ability to repay its debt says Athens won't be able to raise money on financial markets until 2021, unless banks take steeper losses on their bondholdings.

A person familiar with the report says a deal reached with banks in July to give Greece easier terms on its bonds would leave it with a debt of 152 percent of economic output in 2020. The person says the analysis includes a "more realistic" assessment of growth, privatizations and deficits. The person spoke on condition of anonymity, because the report is confidential.

A German official said earlier that Berlin was now pushing for a new deal with Athens' private creditors that would reduce Greece's debt to some 120 percent of GDP by 2020.

THIS IS A BREAKING NEWS UPDATE. Check back soon for further information. AP's earlier story is below.

BRUSSELS (AP) -- The finance chiefs from the euro's 17 countries hunkered down Friday to overcome differences over how to strengthen a bailout fund, which is key to preventing the currency union's debt troubles from spinning out of control.

Giving the euro440 billion ($607 billion) European Financial Stability Facility much more firepower is considered essential before the eurozone can deal with its two other main problems: cutting Greece's massive debts and forcing weak banks to boost their capital buffers to shore up their defenses against worsening market turmoil. "Once we have the option for the leveraging (of the EFSF) then -- building on that -- we can develop all other points," said Austrian Finance Minister Maria Fekter, as the arrived for the meeting in Brussels.

Markets appeared to be giving Europe the benefit of the doubt, trading substantially higher Friday even though a wide-ranging plan to deal with the crippling debt crisis won't be in time for Sunday's summit of EU leaders. A second summit on Wednesday has been scheduled, and officials said a second eurozone finance ministers' meeting would likely be held Tuesday.

"Considering the importance of the discussions and their potential impact upon the European economy, global capital markets and the future of the EU itself, a delay of a few days is neither here nor there in the overall scheme of things," said Gary Jenkins, an analyst at Evolution Securities. "However the suggestions that they are still far apart on how to make best use of the EFSF is of some concern."

Governments have ruled out increasing their financial commitments, but they acknowledge that with some euro140 billion already going to Ireland, Portugal and Greece, the EFSF isn't big enough to both help recapitalize weak banks and keep big economies like Italy and Spain from being dragged into the crisis. A failure to agree on the best way of maximizing the fund's impact between Germany and France forced European leaders to call the second crisis summit for Wednesday.

Austria's Fekter said up to seven technical options for giving the EFSF more leverage were currently on the table and both she and German finance minister Wolfgang Schaeuble ruled out the possibility that the fund will be able to tap into the vast resources of the European Central Bank. That proposal is still being pushed by France, which sees ECB help as the best way of giving the EFSF the necessary force.

A high-ranking German official, who declined to be named, said that a combination of two options had crystallized as the most likely solution. The first would involve the bailout fund acting as an insurer for bond issues from wobbly countries like Italy. That would essentially compensate investors against a first round of losses and help to support their bonds and keep the borrowing costs from rising too far.

In addition, the International Monetary Fund -- which has already provided about a third of the bailout cash for Greece, Ireland and Portugal -- would supply other stragglers with precautionary credit lines to make sure they have ready access to cheap money.

Last weekend, at a meeting in Paris, the finance chiefs from the Group of 20 leading economies opened the door for a larger role by the IMF, but only if the eurozone first does its part. IMF Managing Director Christine Lagarde, who joined the ministers in Brussels Friday, said that her institution would do everything it could to help Europe. "We will find solutions," she said, without going into details.

Europe's leaders have already told their counterparts in the G-20 that they will have a plan ready to present to them at their next meeting in Cannes, France, in early November. But Jean-Claude Juncker, the prime minister of Luxembourg who also chairs the meetings of eurozone finance ministers, said the announcement to delay all decisions until the next summit on Wednesday looked "disastrous" to the outside world. He also canceled a press conference that had originally been scheduled for after Friday's meeting, indicating that hopes were low of having clear results to present.

There appeared to be some progress on finding a solution on Greece, which has been paralyzed for much of this week. Sporadic outbreaks of violence during a two-day general strike against the government's austerity program claimed the life of one person on Thursday.

The German official said the aim was to bring Greece's debt down to about 120 percent of economic output, from more than 180 percent it is set to reach next year. That would most likely involve the banks taking a bigger hit on their Greek bond holdings, hence the need for a widespread recapitalization plan.

In nearly identical statements Thursday night, German Chancellor Angela Merkel and French President Nicolas Sarkozy asked Greece to immediately enter into discussions with private creditors on bringing its debt down to a sustainable level.

Sunday's summit will also examine setting up a permanent system to oversee Greek reforms, replacing the current quarterly visits by the IMF, ECB and European Commission debt inspectors known as the troika, which was "too nerve-wracking for everyone," the German official said. A permanent body in Athens would also be able to react more quickly if Greek reforms were once again veering off target.

European leaders braced for a six- day battle over how to save Greece from default, shield banks from the fallout, and build more powerful defenses against the debt crisis rocking the 17-nation euro economy.

With President Barack Obama stressing the "urgency" of a fix, divisions between Germany and France festered as finance ministers arrived in Brussels for the start of the anti-crisis marathon. As a first step, they are set to approve releasing the next aid payment for Greece. Europe’s international image is "disastrous," Luxembourg Prime Minister Jean-Claude Juncker told reporters before the meeting began. "We’re not really giving a great example of a high standing of state governance."

Aid packages of 256 billion euros ($354 billion) for Greece, Ireland and Portugal have failed to stabilize markets or prevent the turmoil spreading as far as France, co-anchor with Germany of the European economy.

Euro finance ministers meet today, followed by ministers from all 27 European Union countries tomorrow. EU and euro-area leaders gather on Oct. 23, to be capped by another euro summit on Oct. 26. Juncker, the chairman of today's meeting, doesn't plan a press conference afterward. The talks "will be tough and the situation is serious," Dutch Finance Minister Jan Kees de Jager said. "We really need to step up efforts, make extra reforms, extra cuts and strict agreements on budgets."

French-German SplitA falling-out between Germany and France has snagged the crisis management. French President Nicolas Sarkozy is pushing for the use of a European Central Bank role in boosting the firepower of the 440 billion-euro rescue fund, a measure opposed by Germany.

German Finance Minister Wolfgang Schaeuble denied a Berlin- Paris rift, saying Germany called for the second summit to give the government time to consult lawmakers. "France and Germany are not at all stuck in their positions," Schaeuble said. Seven options are on the table for leveraging the fund, known as the European Financial Stability Facility. Germany and the ECB have ruled out granting it a banking license, the most potent option.

"New ones are coming into the process because smart people are looking for creative options," Austrian Finance Minister Maria Fekter said in an interview. "None of the models are amazingly better than the others."

Combining Funds One way under consideration to break the deadlock is by keeping the EFSF going instead of replacing it with a planned permanent fund, two people familiar with the discussions said yesterday.

The resulting combination of the EFSF and 500 billion-euro European Stability Mechanism would deliver 940 billion euros to impress the markets, the people said. A consensus is emerging to start the ESM in mid-2012, a year ahead of schedule, they added.

Juncker said today’s meeting will sign off on the payout of an 8 billion-euro loan to Greece, the sixth installment of a 110 billion-euro package awarded in May 2010. Greek lawmakers clinched that payment by passing fresh austerity measures yesterday, as hooded protesters threw rocks and battled riot police outside the parliament in Athens.

Debt Swap Officials are considering five scenarios to update a July agreement that foresaw 21 percent losses on Greek debt for private bondholders, people familiar with the deliberations said. They range from sticking with a voluntary swap to a so- called hard restructuring that forces investors to exchange Greek bonds for new ones at 50 percent of their value, the people said.

A deepening recession and delays in enacting budget cuts have raised Greece’s financing needs by at least 20 billion euros since July, when euro leaders hammered out a 159 billion- euro package, the people said. "The situation in Europe is very difficult," Finnish Finance Minister Jutta Urpilainen said. "Our meeting tonight will be also difficult."

France retreated in a clash with Germany over how to expand the power of Europe’s bailout fund as finance ministers entered the second of a six-day marathon to stave off a Greek default and shield banks from the fallout.

The French proposal that the fund, the European Financial Stability Facility, should get a banking license enabling it to borrow from the European Central Bank, "is no longer an option" said Dutch Finance Minister Jan Kees de Jager told reporters today in Brussels. He said two options were under consideration, declining to discuss them further. Still, there are "big differences" among countries, he said.

The French flexibility indicated progress toward easing the threat to the global economy stemming from Greece. As they began their consultations yesterday, the euro-area finance chiefs received an assessment from auditors that Greek finances have taken a "turn for the worse," requiring more official aid and deeper investor writedowns.

Stocks and the euro rallied on signs that policy makers may heed prodding from global leaders including President Barack Obama to calm global markets. Officials are also considering unleashing as much as 940 billion euros ($1.3 trillion) to fight the debt crisis, almost double the current ceiling, by combining the 440 billion-euro EFSF and its planned successor, the European Stability Mechanism.

Bank RecapitalizationThe 27 European Union finance ministers today are addressing the framework for bank recapitalizations, De Jager said. French President Nicolas Sarkozy and German Chancellor Angela Merkel were set to meet later before a summit tomorrow and a follow-up gathering on Oct. 26 to nail down what they have called a "comprehensive" plan. Luxembourg’s Jean-Claude Juncker said today that no decisions were likely until then.

Aid of 256 billion euros for Greece, Ireland and Portugal has failed to stabilize markets or prevent the turmoil from spreading to France, co-anchor with Germany of the European economy. French bank shares have tumbled on concern they are vulnerable to losses around Europe’s periphery.

With French bond premiums against Germany at euro-era highs, France yielded to opposition from both the ECB and its neighbor and largest trading partner. The Franco-German split centered on how to leverage the EFSF. While Germany endorsed enabling it to insure a portion of cash-strapped nations’ bond sales, France wanted to turn it into a bank that could tap the ECB.

'Everyone Knows'"Everyone knows the reticence of the central bank and everyone also knows of the reticence of the German position," French Finance Minister Francois Baroin said on Oct. 19. "For us it is and will remain the most effective position. The Americans do it, the British do it." After the first round of talks yesterday, Baroin said that "is not a definitive point of discussion for us." "What matters is what works," he said.

The start of yesterday’s meeting was overshadowed by the report by the European Commission, the ECB and the International Monetary Fund on Greece that highlighted the scope of fixing Greece’s finances without sending shockwaves through the banking system.

Officials are considering five scenarios to update a July agreement that foresaw 21 percent losses on Greek debt for private bondholders, people familiar with the deliberations said. They range from sticking with a voluntary swap to a so- called hard restructuring that forces investors to exchange Greek bonds for new ones at 50 percent of their value, the people said.

Bank Talks"We have to discuss with the private sector and see what is suitable," Spain’s Elena Salgado told reporters. Ministers discussed investor losses of "more than 21 percent," she said. Talks on investor losses in Greek holdings won’t be addressed by the 27 ministers today as they were a topic for the 17 euro countries.

Divisions over the handling of Greece were thrown into relief by the report, which was obtained by Bloomberg News. It contained a footnote that the ECB, which has lobbied against writedowns, "does not agree" with the inclusion of the bond- loss scenarios.

The ministers yesterday signed off on the payout of its 5.8 billion-euro share of an 8 billion-euro loan to Greece. It’s the sixth installment of a 110 billion-euro package awarded in May 2010. A deepening recession and delays in enacting budget cuts have raised Greece’s financing needs by at least 20 billion euros since July, when euro leaders hammered out a 159 billion- euro package, the people said.

Greek Needs"Given still-delayed market access, large-scale additional official financing requirements would remain, estimated at some 114 billion euros," according to the auditors’ report, dated yesterday. "To get the debt down further would require a larger private-sector contribution" of at least 60 percent to reduce debt below 110 percent of gross domestic product by 2020.

The government in Athens forecasts the debt load next year at about 172 percent of GDP. Greece has said it has the cash to operate until mid- November after a scheduled review of the country’s progress in meeting fiscal targets was suspended for about two weeks last month.

European governments may unleash as much as 940 billion euros ($1.3 trillion) to fight the debt crisis by combining the temporary and planned permanent rescue funds, two people familiar with the discussions said.

Negotiations over pairing the two funds as of mid-2012 accelerated this week after efforts to leverage the temporary fund ran into European Central Bank opposition and provoked a clash between Germany and France, said the people, who declined to be identified because a decision rests with political leaders.

Disclosure of the dual-use option helped reverse declines in U.S. stocks and the euro on speculation it could help break the deadlock among European leaders. Their wrangling led to the scheduling of a summit three days after an Oct. 23 gathering. "Incrementalism is better than holding pat," said Marc Chandler, chief currency strategist at Brown Brothers Harriman & Co., in a telephone interview from London. "This is incrementalism."

The 440 billion-euro European Financial Stability Facility has already spent or committed about 160 billion euros, including loans to Greece that will run for up to 30 years. It is slated to be replaced by the European Stability Mechanism, which will hold 500 billion euros, in mid-2013.

Permanent Fund A consensus is emerging to start the permanent fund in mid-2012, the people said. During the transition between the two funds, euro-area governments originally agreed to cap overall lending at 500 billion euros, a figure deemed sufficient when Greece, Ireland and Portugal were the primary victims of the debt crisis.

Widening bond spreads in Italy, Spain, Belgium and France have thrown off those calculations, with multiple uses --primary and secondary market bond purchases, credit lines and bank aid in addition to loans to governments -- now planned for the rescue instruments.

Officials have discussed scrapping Article 34 of the ESM treaty, which sets the combined lending cap, the people said. A revised treaty is due to be signed by the end of November and requires approval by the 17 euro-area governments, usually in parliamentary votes.

Parliamentary ratification has snagged Europe’s crisis response so far. Germany’s parliament attached conditions to its approval of the EFSF’s latest upgrade and the ratification fight in Slovakia cost the prime minister her job.

U.S. stocks gained today, with the Standard & Poor’s 500 Index adding 0.5 percent after losing as much as 1 percent. The euro climbed to $1.3781 in New York from as low as $1.3656.

ECB Opposition The focus on the lending ceiling came after central bankers ruled out giving the EFSF a banking license, blocking the most potent option for scaling it up. France has pushed Germany to go beyond a less powerful, ECB-backed option of using it to insure 20 percent to 30 percent of new bond issues.

Still, the 280 billion euros left in the EFSF cannot be wholly committed to bond insurance, since that would drain the fund to zero, the people said. Instead, finance ministers are likely to decide on the use of the EFSF’s instruments on a case- by-case basis, the people said. Faster startup of the ESM would widen Europe’s options and save money, the people said. The ESM will operate with paid-in capital, moving away from the guarantee-based system that complicated the EFSF’s use.

While speedier enactment would require donor countries to pay in as of 2012, those costs would be more than offset by switching from the guarantee system, the people said. Donor countries would save 38.5 billion euros, with Germany saving 11.5 billion euros and France 8.6 billion euros, according to staff estimates reported by Bloomberg News on Sept. 24.

Eurozone finance ministers said Saturday they have agreed that banks should accept substantially bigger losses on their Greek bonds, with a new report suggesting that writedowns of up to 60 percent may be necessary.

The report from Greece’s international debt inspectors, which formed the basis for discussions at the finance ministers’ meeting Friday, says that in order to keep rescue loans from the eurozone to the €109 billion ($150 billion) foreseen under a second bailout deal tentatively reached in July, Greece’s debt would have to be cut by 60 percent. Even that would leave the country’s debts at a high 110 percent of economic output in 2020.

"Yesterday we agreed that we need a substantial increase in the contribution from the banks," said Jean-Claude Juncker, Luxembourg’s prime minister who also chairs the meetings of eurozone finance ministers. That means the July deal, under which banks would have taken writedowns on their Greek bondholdings of about 21 percent, is definitively off the table.

Austria’s Finance Minister Maria Fekter told journalists that the eurozone’s chief negotiator Vittorio Grilli had been asked to restart negotiations with banks. The agreement to push for much bigger losses is a key step in helping Athens eventually dig out from underneath its debt burden. But asking banks to more significantly write down their Greek debt will raise concerns about their ability to withstand the losses as well as the ensuing turmoil on financial market.

As a result, the finance chiefs from the 27 EU countries, meeting Saturday in Brussels, are also expected to force banks across the continent to raise billions in capital for their rainy-day funds. Both measures are critical to solving Europe’s debt crisis, which is now threatening to engulf larger economies like Italy and Spain and is blamed for dampening growth across Europe and even the world.

"The crisis in the eurozone is doing real damage to many of the European economies, including Britain," George Osborne, Britain’s chancellor of the exchequer, said as he headed into Saturday’s meeting. "We have had enough of short-term measures, sticking plasters that get us through the next few weeks."

European leaders had promised a solution would come from a summit on Sunday — following the two days of finance ministers’ meetings — but they have now scheduled another get-together of EU leaders for Wednesday. Still, this weekend, they appeared to be making progress.

Pressure on finance ministers was high, after the report from Greece’s debt inspectors — the European Commission, the European Central Bank and the International Monetary Fund — showed that the country’s economic situation had deteriorated dramatically since the summer.

If the July deal with banks were to go ahead, the report said, Greece’s debt would peak at a massive 186 percent of economic output in 2013 and only decline to 152 percent by the end of 2020.

That would prevent Greece from raising money on the markets until 2021 and require the eurozone and the IMF to put in an extra €252 billion ($350 billion) in new loans through 2020, according to the report, which was given to the ministers on Friday and seen by The Associated Press. Greece has already been relying on €110 billion in international emergency loans since May last year.

Banks cannot rely on taxpayers' money to recapitalise themselves, Sweden's Finance Minister said on Saturday ahead of a meeting of EU finance ministers that was due to discuss steps to strengthen the European banking system.

"I think we should not use taxpayers' money," Anders Borg told reporters. "The guarantee system alone cannot solve solely the problems. We have to restore credibility with capital."European leaders are holding a series of meetings to try to resolve Greece's worsening debt crisis and its knock-on effects on the European banking system. No decision is expected at a summit on Sunday and a second summit has been scheduled for Wednesday.

EU finance ministers are trying to make the European banking system more resilient to the possibility of a default in Greece and any wider contagion across the continent. EU officials say almost 100 billion euros is required to shore up the region's banking system. Banks that cannot raise money on the markets will have to turn to national governments, and finally to the European Financial Stability Facility (EFSF).

European banks will be required to increase their core tier one capital ratio to 9 percent to help them withstand losses on sovereign debt, banking sources have said. Deep divisions between France and Germany over the best way to scale up the euro zone's bailout facility have prevented agreement on the way forward, but there were signs on Friday that some progress had been made.

German Chancellor Angela Merkel, French President Nicolas Sarkozy and Europe's top two officials, European Council President Herman Van Rompuy and European Commission President Jose Manuel Barroso, will meet late on Saturday to try to break the deadlock before Sunday's summit. EU leaders will then try on Sunday to agree a comprehensive plan to resolve the two-year-old debt crisis, and will meet again on Wednesday if necessary.

Discussions are expected to include ways to make Greece's debt mountain more manageable. An analysis by the EU and the International Monetary Fund showed on Friday that private holders of Greek debt may need to accept losses of up to 60 percent on their investments in any credible plan. "It is pretty obvious we need a substantial haircut for Greece," Swedish Finance Minister Borg told reporters on Saturday.

Austrian Finance Minister Maria Fekter told reporters euro zone finance ministers had appointed Italian Treasury official Vittorio Grilli to negotiate heavier writedowns on Greek debt with private investors as part of a second aid package. Grilli is head of the EU's Economic and Finance Committee.

Greece's finance minister welcomed a decision late on Friday by euro zone finance ministers to approve an 8 billion euro loan tranche that Athens needs next month to pay its bills. "The disbursement of the sixth tranche is an important and productive step," Evangelos Venizelos told reporters on Saturday. "Greece is not the central problem, now the point is to take more general and more constructive decisions for the euro zone as a whole."

The US is becoming increasingly impatient with Europe's seeming inability to solve the ongoing euro crisis. Many in the United States think they know who is to blame: Germany.

For once, US President Barack Obama sounded satisfied. "Chancellor Merkel and President Sarkozy fully understand the urgency of the issues in the euro zone and are working diligently to develop a comprehensive solution that addresses the challenge," reads a White House press office statement on a Thursday video conference involving the three leaders, in addition to British Prime Minister David Cameron.

The message could, of course, be seen as one of many such White House statements issued each year expressing confidence in allies as they face difficult problems. But Thursday's statement stands in sharp contrast to the trans-Atlantic bickering that has accompanied Europe's search this autumn for a solution to its growing common currency crisis. And it obscures the truth: Many in the US think Europe -- and Germany in particular -- has taken a wrong turn.

"It's hard to detect which matters more: German behavior over Libya or its course in the management of the euro crisis," writes Ulrike Guérot of the European Council on Foreign Relations in a recent essay. "But, in short, most US analysts believe that Germany got both wrong."

As if to highlight the impression of European bumbling, the EU on Thursday announced that a second summit was to be held next Wednesday in addition to the one scheduled for Sunday. Paris and Berlin have simply been unable to agree on how best to maximize the impact of the euro backstop fund, the European Financial Stability Facility (EFSF), and need a few more days for talks.

The debate over the EFSF has been going on for months, as has a concurrent and equally rancorous discussion over how best to approach Greece's ongoing reliance on outside financial assistance. The solution, as leaders across the European Union have said in recent months, is more Europe. Greater integration, they say, is the only way to provide the kind of political framework necessary to ensure the stability of a currency like the euro.

That will take time, though. What is needed now, however, is a quick fix -- one that will reassure the markets that Europe has the problem under control.

European DawdlingWith global financial markets becoming increasingly nervous, the US has been watching closely. In September, Obama had finally had enough. In a speech in California, he said that European dawdling was "scaring the world." He added that "they're trying to take responsible actions, but those actions haven't been quite as quick as they need to be."

Berlin's response has bordered on impolitic. "It's always much easier to give advice to others than to decide for yourself. I am well prepared to give advice to the US government," said Finance Minister Wolfgang Schäuble. In an interview with the tabloid Bild am Sonntag last Sunday, Foreign Minister Guido Westerwelle said: "I can't understand some of the critical comments from our American friends regarding our policy of reducing debt."

Even Merkel herself joined in, blasting the US for its unwillingness to support an international financial transaction tax. "It can't be that countries outside the euro zone, which continuously push us to solve the debt crisis, comprehensively reject a financial transaction tax," she said. "I don't think that's okay."

The US isn't alone with its growing discomfort. Last week, Cameron told the Financial Times that European leaders should take a "big bazooka" approach to tackling the crisis. The piecemeal tactics must come to an end in order to finally resolve the future of the euro zone. "Time is short, the situation is precarious," Cameron warned.

Unusually Large Stakes It seems likely that Europe will indeed find a way out of the current impasse by Wednesday's summit. Merkel and Sarkozy have always found last minute resolutions to similar disagreements in the past. And with financial chaos looming, the stakes are unusually large.

But, says Guérot, the debate has been instructive regarding Germany's current role in the new Europe and frustration with which the US has viewed that role. Germany is insisting on a solution to the debt crisis which does not involve positioning the European Central Bank as the funder of last resort. That means no euro bonds. And it means no banking license for the EFSF.

The debate, though, says Guérot, has gone beyond a rational discussion of the issues at hand. "If it is a carrot and sticks game, Germany is only on the sticks side," she told SPIEGEL ONLINE. "I think it has become a real war of orthodoxy. It is a real tragedy for Europe."

Both Cameron and Obama, to be sure, have clear domestic political motivations for pointing their fingers at the Continent. The British economy has once again come to a standstill after experiencing a mini-upswing, and Cameron is under pressure to soften his government's austerity measures. He benefits from the suggestion that a possible recession is not the result of Conservative policy, but of the political chaos across the English Channel.

Governance Problems For Obama, the situation is even more dire. His re-election next year could depend on the state of the US economy. And should the euro stumble, the already stagnant US economy -- complete with stubbornly high unemployment -- is sure to take a dive too.

"If Europe does not deal with the problem of undercapitalized banks, it could easily blow up and turn into another worldwide conflagration," said Obama's former chief economic advisor Austan Goolsbee in a recent interview with SPIEGEL. "Europe as a whole has certainly been too hesitant. Germany is part of the leadership in the euro area -- and it has not yet stepped up and done what has got to be done."

The message from Guérot is similar. Adjusting European structures to where they need to be to ensure the euro's success will not be easy, she says. "The US has real economic problems," she says. "The EU has governance problems."

Before the tsunami, Japan was already battling years of stagnation. Now some say it could happen here too

The pulsating kaleidoscope of colour that turns stultifying Tokyo days into neon-lit nights means that, after dark at least, it looks like nothing has changed in one of the most exciting cities in the world.

No pace has been lost in the frenetic morning commute either, as office workers battle through the capital's sweaty streets to get to their desks on time. The differences are more subtle than that. At the end of their journey they are not greeted with a welcome blast of cold air: offices are dim and clammy as companies economise on lighting and air conditioning following power shortages triggered by the Fukushima crisis.

Japan's physical recovery from the devastation wrought by the huge earthquake and tsunami in March appears to have been swift outside the worst-hit zones. For the economy, however, emerging from the barren years dubbed the "lost decade" is a slower, more painful process. Talk of a similar era for Europe might be seen as economic scaremongering but the warning should perhaps be taken seriously when it comes from business leaders in a country that has endured the phenomenon.

Yukitoshi Funo, a senior executive at Toyota, one of Japan's largest firms, says the country has been in the doldrums since the 1990s and that Europe now faces its own decade of financial inertia as world leaders scramble for a solution to the eurozone crisis. "I am not sure if it is a lost 10 or lost 20 years – but it is about to happen on a global scale, and that is a very big problem," he says.

Despite the sweltering heat outside the car firm's Toyota City HQ, Funo cuts a temperate, bookish figure and hardly seems the type to press the panic button without consideration. But he fears that Europe, and perhaps the world economy, is about to enter the wilderness years.

The so-called lost decade was triggered by racy property lending in the 1980s that saw, in an oft-repeated anecdote, the grounds of the Imperial Palace in Tokyo valued at more than all the real estate in California. The Japanese government tried numerous emergency measures including boosting public spending and quantitative easing, but these measures were considered too little too late, and at one point their effect was cut short by an ill-timed rise in VAT. Ever since, Japan has drifted, dipping in and out of recession. Ring any bells?

At one of Toyota's closest rivals, Nissan, Andy Palmer, executive vice-president and the company's most senior-ranking Briton in the company, says European countries ought to pay close attention to the lessons learned by Japan. He advocates the harsh medicine dished out by the UK government and laments the "complacency" and near-bankruptcy that afflicted his company until it formed a life-saving alliance with France's Renault in 1999. "The lesson is: do what you know needs to be done, whether you are a British company, the British government or a European government," he says.

"When you are in debt, you stop spending," Palmer adds. "I am watching the UK with some admiration because there seems to be the will to take action on austerity, despite opposition. As a company, it's the same. When the chips are down, you cut the cloth to fit your means. The companies that recognise the business model has changed are the ones that will come through the chaos."

In cities such as Tokuyama, Yokohama, Nagoya and Tokyo there is scant evidence of the economic wasteland that "lost decade" implies. In Japanese boardrooms, however, there is a sense of resignation about the home market, coupled with an unsentimental attitude about the action required: look elsewhere.

Japan accounts for just 16% of sales at the construction and mining machinery firm Komatsu, with China now the company's biggest customer. "Komatsu does not generate any business domestically. We gain from exports," says its chairman, Masahiro Sakane, who believes Japan needs to cut deficit spending and boost the role of women in the economy.

"If we take advantage of this potential then we can achieve a new, reborn Japan. If we just take the model of spending on public works here and there, then all that large amount of investment may be wasted. Our [financial] burden will be a very heavy burden again. Japan is at a very critical turning point."

While Japan wrestles with how to revive its domestic economy, exports continue to fill the gap. At Hitachi's train factory in Tokuyama, workers are waiting to build the prototypes for the carriages that will replace the British Intercity 125s. In Yokohama, Nissan's headquarters give pride of place to the Leaf electric car, which will be built at overseas sites including the Nissan factory in Sunderland, and in Toyota City Funo explains that Japan is only one of "six wheels" now driving the business.

If this means Britain should battle through a looming lost decade by replicating Japan's strengths in manufacturing, known as monozukuri, then there are pitfalls too. The phrase cho-endaka, or super-strong yen, is being uttered a lot by Japanese executives because, at about ¥76 to the dollar, it sends costs through the roof as well as making exports too expensive. The government is reportedly preparing to spend ¥4tn (£33bn) on capping the currency's rise. While the British business secretary, Vince Cable, bemoans an unbalanced UK economy that lacks sufficient manufacturing heft, it could be argued that Japan has the same problem – except that it is industry that is tipping the scales too far.

For Japan, this macroeconomic quandary is being debated as the government battles to reconstruct Tohoku, the north-east region devastated by the earthquake, tsunami and nuclear disaster.

A two-hour train ride north of Tokyo, the Renesas Electronics plant is running normally after a huge effort restored a site that had been reduced to rubble by the shocks which left it unable to produce the microcontroller chips that are crucial to Japan's motor industry. Renesas's Shuichi Inoue admits car firms may buy their products elsewhere, perhaps abroad. "That risk is always there. We don't want that to happen but, from a customer's point of view, of course they will want to think about that."

Concerns about manufacturing disappearing or moving abroad are a familiar refrain in the UK and some economists think Japan could do with exporting less and consuming more anyway. Jeegar Kakkad, former senior economist at the UK manufacturers' association the EEF, says: "Although the tsunami proved devastating for Japan, the country should use it as a fillip to build better-balanced foundations for their economy."

At next month's G20 summit in Cannes, much of the focus will be on Nicolas Sarkozy and Angela Merkel. But everyone should heed the painfully earned wisdom of the Japanese delegation. "A landing should happen," says Funo. "The question is whether it is going to be a soft landing or a hard landing. It is an unknown." He says European banks are retreating from lending already: "My view is this contraction is already happening."

He adds that emerging economies have helped Toyota continue to grow despite the US downturn., but that could be endangered by the eurozone crisis. "European finance was fuelling the emerging economies; it played a significant role. So therefore when European finance contracts, that is a problem. It is already heading towards that direction. It is fate."

William Prince, of Rosenberg, Texas, knows just how inescapable student loans can be. The 52-year-old father of two started paying off $51,000 in college debt 15 years ago and now owes $57,000. "I don't expect to pay these loans off in my lifetime," he says. Prince, a criminal justice major who works in private security, had to defer payments during three bouts of unemployment, and the accumulated interest left him deeper in debt.

Americans now owe about $950 billion in student loans — more than their total credit-card debt. The weight of those IOUs is a frequent refrain for Occupy Wall Street protestors and their online supporters. On the "We Are the 99 Percent" Tumblr blog, which features hundreds of pictures of people holding handwritten signs describing their desperate financial situations, student loan concerns exceed those about children, unemployment, and health care, according to an analysis by Mike Konczal, a fellow with the nonprofit Roosevelt Institute.

Desperation may have something to do with that outcry. Two out of five Americans with federal student debt can't make monthly payments and either defer, default or are delinquent, according to Mark Kantrowitz, publisher of Fastweb.com, a free scholarship-matching service, and FinAid.org, a source of student financial aid information. Although the laws are gradually changing, student debtors' odds are still grim. The best means they have of one day growing free of those debts is to know the system.

Eroded Borrowers' Rights There are very few ways to reduce or renegotiate education debt; unlike credit-card debt, few can do this via bankruptcy. "There has been a steady erosion in rights for student loan borrowers," says Deanne Loonin, an attorney at the National Consumer Law Center. Activists and some congressional Democrats argue that Congress should again allow borrowers to discharge student debts in normal bankruptcy — a right lost in a 2005 law. They also ask for better supervision and limits on debt collection. Such improvements could be years away, if they ever take place.

For federally backed loans, the situation is better, though still far from perfect. The government can seize wages, tax refunds, earned income tax credits and even Social Security. One of Loonin’s clients, an 84-year-old man, once took out a student loan for a relative; the payments now amount to about 40 percent of his Social Security checks, leaving him with a bit more than $750 each month.

The federal government is taking steps that could make the debt burden more manageable. A provision in the 2010 health-care reform law pushed private lenders out of the business of issuing federally guaranteed loans. The 2010 Dodd-Frank financial reform law puts the new Consumer Financial Protection Board in charge of collecting better data and regulating private student lenders. The new agency also is planning to launch an online tool — a "student debt assistant" — to help debtors learn more about their options.

Income-Based Repayment One option introduced in 2009 is income-based repayment. It allows borrowers to repay federal loans as a percentage of the prior year's adjusted gross income, capped at 15 percent. (If a borrower's circumstance changes from the prior year, he or she can request recalculation.) Under so-called IBR, all federal loans are forgiven after 25 years — 10 years for those in nonprofit or public service jobs. A 2010 change in the law means that for borrowing that begins in 2014, payments are capped at 10 percent of income and all debts are forgiven after 20 years.

Because no payments are required on income below 150 percent of the poverty line, income-based repayment is helpful for such borrowers as 28-year-old Jennifer Sandella. She earns so little that she doesn’t need to pay anything on her $45,000 in graduate school loans. For a single person, 150 percent of the poverty line is $16,335; for a family of three, it's $27,795.

Two years after the program was introduced, few borrowers know about IBR. Only about 1 percent of federal borrowers — out of the 10 percent who could benefit — are enrolled, Kantrowitz estimates. The U.S. Department of Education has been offering information about IBR on its website, through customer-service representatives, and to students when they exit school. It now plans to contact current borrowers to inform them about the program, says spokeswoman Sara Gast.

The program has drawbacks. Persons with private loans, such as Prince, aren’t eligible. And any unpaid interest is added to debt until loans are eventually forgiven. "I'm still accruing interest at a phenomenal rate," Sandella says. If she never manages to pay her loans off and her debt is forgiven after the 25-year mark, the amount forgiven will be taxed as income, perhaps triggering a big bill from the IRS.

Few Options for Private Borrowers Those with private loans have little leverage when negotiating with their lenders. Student loans can be forgiven in bankruptcy only if debtors take lenders to court and prove an "undue hardship" — a legal step taken by merely 0.1 percent of eligible debtors. Of those, about half got relief, according to a 2011 analysis by Harvard Law student Jason Iuliano.

The Consumer Bankers Association, which represents private lenders, said in a statement: "Banks work with borrowers experiencing financial hardship on private student loans" by, for example, allowing borrowers to temporarily suspend payments.

The best way to avoid being trapped by debt is to restrain it from the start. Students need to "shop around for schools to limit how much they need to borrow," says Lauren Asher, president of the Institute for College Access & Success, a nonprofit advocacy organization that runs the Project on Student Debt. Regulators and colleges could do much more to steer young students toward more manageable debt loads, she says.

"Inadequate information and aggressive marketing tactics can have an effect on people," Asher adds, noting that many students take on private loans even though they are eligible for less-risky federal loans. Dependent students can borrow up to $5,500 in federal loans as college freshmen, while their parents can borrow up to the total cost of attendance, minus other aid.

Colleges are required to provide counseling to student borrowers when they exit school. They "are always looking for ways to do it better," says Terry Hartle, senior vice president for government and public affairs at the American Council on Education. But it's not clear how much of that counseling sinks in. Says Hartle: "I'm afraid an awful lot of college students only learn how much they've borrowed when they begin repayment."

Think life is not as good as it used to be, at least in terms of your wallet? You'd be right about that. The standard of living for Americans has fallen longer and more steeply over the past three years than at any time since the US government began recording it five decades ago.

Bottom line: The average individual now has $1,315 less in disposable income than he or she did three years ago at the onset of the Great Recession – even though the recession ended, technically speaking, in mid-2009. That means less money to spend at the spa or the movies, less for vacations, new carpeting for the house, or dinner at a restaurant.

In short, it means a less vibrant economy, with more Americans spending primarily on necessities. The diminished standard of living, moreover, is squeezing the middle class, whose restlessness and discontent are evident in grass-roots movements such as the tea party and "Occupy Wall Street" and who may take out their frustrations on incumbent politicians in next year's election.

What has led to the most dramatic drop in the US standard of living since at least 1960? One factor is stagnant incomes: Real median income is down 9.8 percent since the start of the recession through this June, according to Sentier Research in Annapolis, Md., citing census bureau data. Another is falling net worth – think about the value of your home and, if you have one, your retirement portfolio. A third is rising consumer prices, with inflation eroding people's buying power by 3.25 percent since mid-2008.

"In a dynamic economy, one would expect Americans' disposable income to be growing, but it has flattened out at a low level," says economist Bob Brusca of Fact & Opinion Economics in New York.

To be sure, the recession has hit unevenly, with lower-skilled and less-educated Americans feeling the pinch the most, says Mark Zandi, chief economist for Moody's Economy.com based in West Chester, Pa. Many found their jobs gone for good as companies moved production offshore or bought equipment that replaced manpower.

"The pace of change has been incredibly rapid and incredibly tough on the less educated," says Mr. Zandi, who calls this period the most difficult for American households since the 1930s. "If you don't have the education and you don't have the right skills, then you are getting creamed."

Per capita disposal personal income – a key indicator of the standard of living – peaked in the spring of 2008, at $33,794 (measured as after-tax income). As of the second quarter of 2011, it was $32,479 – almost a 4 percent drop. If per capita disposable income had continued to grow at its normal pace, it would have been more than $34,000 a year by now.

The so-called misery index, another measure of economic well-being of American households, echoes the finding on the slipping standard of living. The index, a combination of the unemployment rate and inflation, is now at its highest point since 1983, when the US economy was recovering from a short recession and from the energy price spikes after the Iranian revolution.

In Royal Oak, Mich., Adam Kowal knows exactly how the squeeze feels. After losing a warehouse job in Lansing, he, his wife, and their two children have had little recourse but to move in with his mother. Now working at a school cafeteria, Mr. Kowal earns 28 percent less than at his last job.

He and his wife now eat out once a month instead of once a week, do no socializing, and eat less expensive foods, such as ground chuck instead of ground sirloin. "My mom was hoping her kids would lead a better life than her, but so far that has not happened," says Kowal.

With disposable incomes falling, perhaps it's not surprising that 64 percent of Americans worry that they won't be able to pay their families' expenses at least some of the time, according to a survey completed in mid-September by the Marist Institute for Public Opinion. Among those, one-third say their financial problems are chronic.

"What we see is that very few are escaping the crunch," says Lee Miringoff, director of the Marist Institute in Poughkeepsie, N.Y.

Income loss is hitting the middle class hard, especially in communities where manufacturing facilities have closed. When those jobs are gone, many workers have ended up in service-sector jobs that pay less.

"Maybe it's the evolution of the economy, but it appears large segments of the workforce have moved permanently into lower-paying positions," says Joel Naroff of Naroff Economic Advisors in Holland, Pa. "The economy can't grow at 4 percent per year when the middle class becomes the lower middle class."

He would get no argument from Jeff Beatty of Richmond, Ky., who worked in the IT and telecommunications businesses for most of his career – until he hit a rough patch. He and his wife are living on his unemployment insurance benefits (which will run out in months), his early Social Security payments, and her disability payments from the Social Security Administration. Their total income comes to $30,000 a year.

"Our standard of living has probably declined threefold," he says.

Mr. Beatty, who used to make a comfortable income, now anticipates applying for food stamps. He and his wife have sold much of their furniture, which they no longer need because they have moved into a one-bedroom apartment owned by his sister-in-law.

Even people with college degrees are feeling the squeeze. On a fall day, Hunter College graduate and Brooklyn resident Paul Battis came to lower Manhattan to check out the Occupy Wall Street protest. He tells one of the protesters that America's problem is the various free-trade pacts it has approved.

Mr. Battis's angst over trade is rooted in the fact that two years ago he lost his data-entry job with a Wall Street firm that decided to outsource such jobs to India.

When he had the job, he made a comfortable income. Now his income is sporadic, from the occasional construction job he lands. He used to buy clothing from Macy's or other department stores. Now he goes to Goodwill or Salvation Army stores. He has even cut back on taking the city subways, instead riding his bicycle. Separated from his wife and his 15-year-old daughter, he says, "Try making child support payments when you don't have a regular income. I'm constantly catching up."

Even recently some Americans could tap the equity in their homes or their stock market accounts to make up for any shortfalls in income. Not anymore. Since 2007, Americans' collective net worth has fallen about $5.5 trillion, or more than 8.6 percent, according to the Federal Reserve.

The bulk of that decline is in real estate, which has lost $4.7 trillion in value, or 22 percent, since 2007. In Arizona, for example, more than half of homeowners live in houses that are worth less than their purchase prices, according to some reports.

Stock investments aren't any better. Since 1999, the Standard & Poor's index, on a price basis, is off 17 percent. It's up 3.2 percent when dividends are included, but that's a small return for that length of time.

"This is really a lost decade of affluence," says Sam Stovall, chief investment strategist at Standard & Poor's in New York.

Among those who have watched their finances deteriorate are senior citizens.

"Given the stock market, they are very nervous," says Nancy LeaMond, executive vice president at AARP, the seniors' lobbying group. "They want to keep their savings."

But Ms. LeaMond also notes that about 2 in every 3 seniors are dependent not on Wall Street but on Social Security. The average annual income for those over 65 is $18,500 a year – almost all of it from Social Security, she says. "This is not a part of America that is rich," she says.

At the same time, seniors are getting pinched in their pocketbooks.

"Our members are watching all the things they have to buy, especially health-care products, go up in price," says LeaMond.

In Pompano, Fla., some stretched seniors end up at the Blessings Food Pantry, which is associated with Christ Church United Methodist.

"We have quite a few grandparents who are raising their grandchildren on a fixed income, feeding them and buying clothes for them when they can't afford to do [that for] themselves," says Yvonne Womack, the team leader.

Others, she says, are forgoing food to pay for their medical prescriptions. "And then there is your ordinary senior whose Social Security [check] has not gone up in the last several years, but food and gasoline [prices] have skyrocketed," she says. (However, Social Security checks will go up 3.6 percent in January.) The Blessings, she notes, is now feeding 42 percent more people than last year. "We also provide food you can eat out of a can," she says. "We do have seniors who are living on the streets."

46 comments:

This is one of the grimmer posts I have seen.I can feel the tension now...the big question is how long will it take for the euro-destuctoid bomb to shut doors of major players here.That move by BOA was to screw the taxpayers...all their poisonous derivatives are now insured/covered by the deposits of those folks in BOA.Please tll me no TAE are still in that place...

yup. An astonishing collection of "we're all down the rabbit hole" stuff. The twists and turns of illogic and fantasy are spectacular. You keep thinking "this just can't get any crazier" - but it does.

from article by Ash - "... but the truth of the matter is that nothing has developed this entire time. The only thing that has happened is that European politicians and officials have publicly admitted they’ve sunken neck deep into the debt-sand and that they are well aware of it.

This paragraph kinda nut-shells the whole situation that our Euro friends find themselves in. And when the dominoes start to fall, we (in the states) will be hit hard as well. The big question is, will it be the "haymaker" that sends us all reeling to a sudden crash? Or ...can the fall be somewhat slowed by manipulations and inventive measures?Thanks to Ilargi, Stoneleigh, and Ash for informing us concisely about the European predicament and possible repercussions. Though it makes me feel like--or rather I'm convinced--that we are on the cusp of a worldwide calamity.I too am feeling Snuffy's "tension."

The only option left to come out of this in a week from now - and you can be sure that's how long it'll take - is something grandiosely hyperbolically nuts. It's all that's left; there's nothing "soft" that would cover everyone's needs and fears. It'll be amusing, but it'll also be time to check one's marbles.

I read this while drinking my first cup of coffee and felt my tumy turn. By 'read' I mean skim faster & faster as the words connected and sank in. I'll have to reread once I've done a few homestead chores & projects, as my personal attempt at control over my future definitely calms & centers me.

Thanks for all the hard work of assembling and analyzing this 'stuff'. No matter what happens, it is helpful to have an inkling of what's coming rather than sit unaware.

World wide, the objective is to save the financial system from which the 0.01% of the elites are benefitting.The 99% has already been thrown to the wolves to save the system.Now its time for the weakest wolves to be devoured by the pack.Which part of the financial system will become the sacrificial lamb?As it has been previously mentioned, the feeding frenzy will begin when the first one tries to leave, (Cash out), what they see as an unfolding blood bath.We can quit the game and take our few marbles but if the big institutions try to take what they perceive as their marbles and quit the game, then all the other payers will be left with no marbles.

I expect that China will be the one that decides when the game is over.

While your analogy with quicksand has nice dramatic value, Europe should be so lucky that the analogy were accurate. Quicksand is rarely deeper than a meter before one hits solid ground underneath. Second, its density is usually about twice that of the human body, so one is unlikely to sink much past the waist. But attempting to thrash about can cause powerful areas of vacuum. Most fatalities occur from the head being under with other parts of the body above the surface. I think an appropriate picture for Europe would be the legs, clad in lederhosen, sticking up in the air.

I also found it reassuring to learn that quicksand is not how it's portrayed in Hollywood movies. You can actually float on it. But you do have know what to do once you're in and it takes careful, coordinated, calm, and slow movements (analogy?):

Our tottering financial structure may soon see an "I'll screw you before you screw me" moment. This is the way humans behave under duress and in uncharted waters. Especially to be expected of (sub)humans currently at the top of the power pyramid. Realpolitik. Last fiat currency standing wins the prize!

The central uncertainty regards how much power TPTB REALLY have and the extent to which it can be excercised effectively in a period of rapid destabilization.

Robbing citizens of their savings viaFDIC default to pay foreign creditors has a transparency/immediacy that is absent in the standard inflation/tax your descendants without mercy/ debt enslavement scenario. And is thus potentially much more destabilizing.

As US protests against legalized politico-financial robbery grow in scope (and this will accelerate because pampered Americans will take a lot less discomfort before reacting than sturdier citizens across the globe) andas the nature of our current predicament becomes less opaque (in spite of MSM efforts at containment) politicians and corporatistas may well find themselves in a pickle which hashas overtones with MQ video-ish nightmares.

Thus our politican-bankster puppets, moral and altruistic creatures that they are, may have an "aha" moment in which they decide that it is expedient to rear up and bite the hands of their puppeteers. Imposition of cross-border currency flows together with selective defaults on debt obligations (no payment on CDSs and treasury obligations to those greedy, dishonest foreigners who started this whole mess in the first place) could cause rapid globalization in reverse but possibly avoid internal sovereign nation strife.Which might be preferable to what will follow,strife between sovereign nations.

Thus as the pirhanas position themselves to attack each other under renewed ultraneonationalism, the propaganda machines will be working overtime to prepare yet another generation of young humans for the slaughterhouse and noncombatants for a markedly reduced standard of living as our fragile last minute living essential purveyance system crashes as its complexity cannot be maintained, except preferentially as the end stage make work program to create weapons that will destroy/conquer "our enemies."

The end result may be a world with far fewer humans living in much smaller communities (the antithesis of globalization) but which will naturally renew itself for another cycle of growthin the long time that remains before ourSun makes life as we know it impossible.At least in the near term, remaining humanity will likely be more spiritual vs material, be concerned with the daily necessities of life, and be behaviorally governed by concepts of decency, fairness and honesty that it is alas cyclically inclined to forget.

My Occupy One Demand is a maximum wage, after which everything is taxed away. I think $250,000 would be reasonable, but I would go higher just to see it happen.

Now, I know that would have no impact on the problems we face, but I think it may be maximally mind-blowing for people who haven't been reading TAE for the past many years.

But what I really want is for investment to equal risk again. The true sign of the Equestrian Class is that Heads they win, Tails I lose. It is so infuriating to see all the arguments about how big the haircut is. You don't get to argue; you invested, it was risky, you lost. No more free money. Maybe the demand is something like: "Your Investment, Your risk. No Bailouts."

Another thing I would really like to see is the stock market doing something useful again, like issuing stocks to build canals, or for a new tractor company. You buy stocks and hold them because you think the company is doing important work and will make money. This trading every second so perverts the point of the stock market. Maybe stocks should have to be held for a year.

Hm. Reading the article about whether Greece is a failed state, and the Greek unions protesting, got me wondering what the new story is.

I am a union man myself, but I think unions lost their way long ago--they fight only for themselves, and not for the good of all (sweeping generalization). I think in this political environment, unions should only strike for someone else's benefit. Raise the minimum wage, or give universal dental care or something like that. Not for higher union wages--that just increases the divide.

Anyhow, it made me wonder if the Occupy movement can write a universal story. Tea Party candidates largely have a universal story--it doesn't really matter what a Froot Loop the local candidate is because people can vote for the story.

I think there is political room for a story of honest work and honest returns, equity and compassion. This story would have to look at the real assets of a country and then give haircuts to everybody, big haircuts for the rich, little haircuts for the unions, tiny haircuts for everyone else. No more two or three car garages stuffed with junk. No more special treatment because you were born rich. No more free lunches.

Absolutely all the articles in this post tighten the tension all around. :(

This can that keeps getting kicked down the road must be pretty battered and deeply dented by now, and maybe a little rusty. Maybe some little holes have appeared through all the bad treatment it has had the past years and months.

Shouldn't it be just about ready to split in pieces?

Our our can--USA--will collide with the EURo can at some point?

thanks for the great info Ilargi, SToneleigh and Ash and the commenters provde.

Steve Keen said that we should have a debt jubilee and that dishonorable debt should not be paid.That is very true but there is no way those bankers are going to agree to that.The word dishonorable bankers dont exist in their dictionary.

"The printing of credit to make whole defaulting debt-assets is in the case of the USD."

Not for sure certain what you mean by "...printing of credit ... "

But on "not sufficient to undermine currency confidence", would you not agree that the confidence in the USD is presently being undermined. Look to China and the amounts of gold etc. it is purchasing in place of treasuries. Even in the US there are quite a few States that are starting to look to PM's as currency, that does not sound like a vote of confidence in the USD. Would you agree that confidence is not the same as the easiest place to run to?

el g Thanks for posting the link to Reggie Middleton’s message on RT. It is another ah,ha moment for me in the opaque world of financial thievery perpetrated by TBTF banks. I see the BOA quietly moving their un-payable derivative exposures to a vehicle with ultimate insurance from the FDIC as a despicable act. We can be assured this will have ramifications for all of us having some types of insured savings. However, I was not prepared for the letter I got from my discount broker in Saturdays mail.

Snuffy,Antidotal evidence…I set up non-margin accounts in 2008 for holding cash and stocks. These accounts now hold only cash, no CD’s or similar instruments. Other non-margin accounts, not mentioned in the letter, have cash invested in a US Government treasury money market fund. These accounts were set up for safety and protection of principal. There is a small amount of interest income but I do not use them for trading and that is the crux of the problem as I see it. Now they say“…uninvested cash in your xyz account must be maintained for the purpose of investing in securities. If there has been no investment activity by Nov. 20, 2011 we will change your cash feature to the FDIC-insured XYZ Bank Sweep feature” Perhaps a brokerage firm is not the best place to park assets and they do have to make money the old fashioned way. Seems strange they want to make this change now. Wall Street wants accounts to trade and isn’t happy to hold your cash. They now want to sweep it into a FDIC-insured account for your safekeeping.

How come some of our bloggers claim to earn £970.000 or to be wearing very expensive watches?

I think the TAE barometer gives us a clue that somebody's telling porkies.

C'mon guys - impress us here if you really can. It'd be smarter to flog your unwanted Swiss chronometers on Ebay while there still a slight pulse of demand, and then put your money where we'd all see it and be wow'ed.

I should have said "not sufficient to undermine currency confidence to the tipping point after which HI is imminent."

It's a relative game. You are correct that international confidence in the USD as reserve currency is waning, but that particular story will play out to its conclusion over a relatively lengthy time period. Meanwhile, the Euro as a long-term store of value in its current form is, of course, a joke, and all other significant currencies have the political will and ability to devalue against the USD. It's a cascading series of tipping points, and the dollar's is still not close.

Just watched "A Farm For The Future". Great film, thanks for posting it. I found it all inspiring, if a bit intimidating. I live in the country, on about 2.5 acres, much of which is wooded or overgrown with bramble and invasives. I have much work to do- I suppose we all do, but those that know it had best get started now.

Donjalu"Sweep" in bankster lingo means the fraction of your deposit "reserved" is a negative percentage.

Countertrend stock rallies in the US have now reached Fibonacci retracements at which a resumption of the major trend(remember folks, this means 3rd of a 3rd wave..picture a vertical dropoff) would not be improbable. C'mon Cheryl, show us those cajones and leverage up!

Wouldn't all accounts at a FDIC bank or NCUA credit union be considered 'sweep' accounts? The money is swept off somewhere else...whether to loan to another person, or business, or even by the bank to speculate.

If an account is labeled specifically to be a 'sweep', what does this mean?

"Researching an article on Chinese intellectuals a few years ago, I was startled to hear many of them channeling -- as guilelessly as they once had the wisdom of Chairman Mao -- the laissez-faire ideology of the Chicago School. In India, too, born-again Friedman-ites and Hayek-ians have a much greater presence than Keynesians in the mainstream press and television.

...This [existence of a pro-capitalist "progressive" middle class] is at least how it seems within the information ecosystem of the global middle class, which is attuned to the desires and fears and preoccupations of people who, for instance, might be reading this column. But there exists outside this relatively tiny circle a wide range of forceful dissent among the lower-level toilers of globalization.

The deteriorating condition of the rural poor and urban workers go largely unreported in the business press in both India and China, which specialize in adoring accounts of successful or on-the-make corporate moguls. Nevertheless, agricultural and factory labor constitute the vast majority of the workforce in populous countries like India and China.

They are what shape political life in their nations far more enduringly than the smooth-tongued Tweeters and Facebookers."

"To help underwater borrowers, or those whose loans are worth more than their homes, FHFA said it will scrap a cap that prohibits any homeowners whose mortgage exceeds 125 percent of the property's value from participating in HARP, which is targeted at loans backed by Fannie Mae and Freddie Mac.

The plan, targeted at borrowers who hold loans backed by Fannie Mae and Freddie Mac, is the latest government effort to deal with a problem at the center of the economy's weak recovery -- a crippled housing market.

"Our goal in pursuing these changes is to create refinancing opportunities for these borrowers, while reducing risk for Fannie Mae and Freddie Mac and bringing a measure of stability to housing markets," FHFA's acting director, Edward DeMarco, said in a statement.

After meeting with DeMarco earlier this month, one lawmaker said the expanded program could help as many as 600,000 to one million borrowers. But that is only a fraction of the estimated 11 million homeowners who are underwater."

Question: How exactly does the expanded backstopping of rapidly sinking mortgages via transferring credit risk from the banks help "reduce risk for Fannie Mae and Freddie Mac [taxpayers]"?

Answer: it doesn't. It does the opposite. In a previous comment a few threads back, I mentioned any "debt forgiveness" policies would target mortgage debt and student loan debt, but would only include "refinancing" operations that are well short of actually forgiving any debt for those who need it forgiven the most. That's what Obama is pushing this week on his propaganda tour, since his jobs bill was the political equivalent of a miscarriage.

Check out the debriefing sections and teaching models to get a layman level understanding of the concepts.http://bilbo.economicoutlook.net/blog/?page_id=14323

Just getting tired of the doomsterism based on flawed neo-liberal economic thinking. Not to say the world still won't go to hell, but this shows us a way out if we aren't too blinkered with outmoded ideology.

Here is a general list of flawed economic theories based on both the flaws in their foundational assumptions and the policy recommendations they imply for returning to "sustainable" economic growth (from most to least flawed):

1) Neo-classical economics (throw in game theory as a natural extension)

2) Friedman's Monetarist theory (a kind of hybrid of #1 and #3)

3) Neo-Keynesian economics (Krugman)

4) MMT or Chartalism (what you referenced; perhaps a subset of #3 above, but not accepted by all)

5) Austrian economic theory (very diverse field; much more practical approach than any of the above, but similarly flawed assumptions to #1 and impractical "libertarian" solutions)

7) Post-Keynesian economics (integrates Marx, Fisher, Minsky, Keynes and aspects of systems theory; still reliant on some impractical policy "solutions", though much more oriented towards analysis)

The latter draws on the insights of MMT about private money creation in pure credit money economies that is not restricted by "reserve requirements", but mostly rejects its simple analysis of "public deficits creating private savings" (it also argues that the Fed can only target interest rates without controlling them or money supply). To say that there is only inflation risk and never any default risk for US sovereign debt ignores a much more complex reality that exists in the global monetary and political systems. There are dynamic, evolving systems that do not obey static laws of accounting.

MMT assumes that a country can rise above the limitations of sovereign debt ponzi schemes by becoming a "currency issuer", rather than simply a "currency user". Yet it ignores the implications of what it would mean for every country to become such issuers (not possible), and the reality that countries without such a luxury will recycle debt-dollars forever, no matter what strains it places on their economies and the system as a whole. Along with other theories listed at the top, it is the quintessential example of idealistic theory and flawed assumptions being trumped by a dynamic reality.

It just came to my attention that since "the economy" is more or less life itself, all the "theories" are more or less philosophies of dead and living dudes trying to make some sense of it all, and of course, failing miserably, on top of pitting various disciples and large swaths of people against each-other.Of course each and everyone of the PHilosophy Dudes has the "if only (insert particular requirement here) is met --> then instant paradise shall be ours and history will stop" line.

You are likely correct that the collapse of the US dollar will take a bit of time, but imagine that same thought in 2000 just before the dot com blowout, something like: "that thought never would even think of beginning to cross the mind", to in 2006 " Goodness gracious, that is thought of only by a few weirdo's on places like the Oil Drum!" to now and "that particular story will play out to its conclusion over a relatively lengthy time period"

Just joshing you a bit Ash, but things do seem to be speeding up and,IMO, all it would take is a bit of a mystery spanner in the works for things to go critical for the decreasingly mighty USD. Let us see what happens with the Nov 3 G20. Could that turn itself into a bit of a spanner when the Geithner hits the Zone? What are your thoughts on how that will turn out for European conflict resolution? That as well is a mystery to me!

Amid the other great Government news today, of an improved program for helping underwater mortgage owners out; comes the news that the Labor Dept. has granted an "exemption" to existing regulations, so poor 401(k) owners can now get "expert advice" on how to "invest" their vanishing retirement funds much more easily. Early press release in toto:

"The Department of Labor has issued a new regulation designed to improve access to expert investment advice for workers with 401(k) and individual retirement accounts.

"The rule makes it easier for providers of 401(k) plans such as Charles Schwab, Vanguard, and Principal Financial to offer their own advice and bundle it with their other services.

"Currently an employer offering a 401(k) from a provider like Vanguard has to contract with a separate independent adviser to comply with regulations against conflicts of interest. Investment advice cannot be offered by anyone who might benefit financially from the advice.

"The regulation, effective Dec. 27, creates an exemption. Advice from 401(k) providers will be allowed if it is based on an unbiased computer model or the adviser's compensation is not affected by the advice."

This in the NYT, which a couple days ago, printed the nice book excerpt from the psychology professor given the Fauxbel in Economics, documenting his work illustrating statistically that the great experts on investment never, ever, do better than chance, and usually worse.

That was a lot of words but you didn't really address how MMT or Post Keynsenism is flawed. It seems pretty straight forward .

The US "is" the sovereign monopolist issuer of its currency. All dollars come from them, that is the system.

In what way is it a ponzi scheme?

You assert: "Yet it ignores the implications of what it would mean for every country to become such issuers (not possible), and the reality that countries without such a luxury will recycle debt-dollars forever"

Why not? Why can't each country have its own sovereign currency? What is the reality that keeps this from happening? It seems like it is a purely political issue.

You also assert:"To say that there is only inflation risk and never any default risk for US sovereign debt ignores a much more complex reality that exists in the global monetary and political systems. There are dynamic, evolving systems that do not obey static laws of accounting."

Actually no. There is no default risk financially because all US debt is in Dollars or Treasuries which the US govt. can create at will from nothing as the issuer of the currency. They could default as a political act but that wouldn't serve much purpose.

All this talk of US govt. debt is a misnomer. There are a bunch of people holding US treasuries which are basically a savings account at the Fed. When they get "paid" all that happens is that the Fed changes the accounts from savings in treasuries to dollars that can be spent. To pay off the "debt" they just create the dollars on a computer.

In fact the US doesn't even have to sell treasuries, this is a vestige of when we were on the gold standard. The Fed could just pay a percentage on the reserves to set the interest rate (which they are now doing).

Tipping points for large systems can occur rapidly, but that does not mean we are unable to get a good sense of how close we are to them. Many of the debt crises over the last few decades were expected by analysts who held a realistic theoretical perspective and kept themselves informed of what was actually occurring.

Same thing with this off-the-charts European crisis. I'm sure no one here is surprised that Greece's debt situation has become exponentially worse, the credit contagion has spread inward from the "periphery" to the "core" and that Euro banks are struggling to remain solvent. So, once again, it is very unlikely a "mystery spanner" sends the USD "critical" anytime soon, and almost all signs point towards near-term appreciation.

"Could that turn itself into a bit of a spanner when the Geithner hits the Zone? What are your thoughts on how that will turn out for European conflict resolution?"

Anything happening in November is irrelevant right now, since it would be greatly dependent on what actually ends up coming out of Europe this week. As a general rule, though, there is bound to be increased conflict anywhere Geithner happens to be.

As a general rule, though, there is bound to be increased conflict anywhere Geithner happens to be.

---------

But they could raise money with this conflict. Their typical lack of imagination. I would suggest a pay per view light / heavy weight tag team wrestling match with Mutti and Timmy as one team and Sarko and Venizelos for the other.

I just realized these sovereign bailouts are your plain garden variety " liar loans ". On Wednesday we will be presented with a plan to save the Euro with terms unmatched by the required revenue to meet them. Isn't this against the law? Somebody has got to be lying about earnings.

"I attended a presentation yesterday and the one thing that surprised me the most, was the apologetic tone of the Germans. They seemed sorry they hadn't done enough and almost seemed to be asking for forgiveness. It was strange, since the largely American audience in most cases had already thought they had done too much. It seems that there is a real struggle (more than I realized) between doing what they think is right and what they think other people think is right. We will see how far this goes. It won't show up in the headlines of any plan, but will be obvious in the details where restrictions are spelled out."

The government won't even go after the banks who made "liar's loans", so don't expect them to go after themselves. Also, "bailouts" by definition are not even loans. In times of "crisis", anything goes.

But, it's good to have a country that recognizes at least a few of its own limitations in the mix.

Telegraph update: "13.45 Germany has made it clear once again that it does not see any kind of expanded role for the European Central Bank in the rescue measures the eurozone is due to announce tomorrow.

Angela Merkel said the country opposes the statement in the draft conclusion that calls for the ECB to keep buying government bonds in the secondary market.

She said Germany does not want a declaration from politicians telling the ECB what to do."

Of course, that's not the same as telling the ECB to stop, and it won't, because it can't. No matter what (if anything) they come up with tomorrow, they are absolutely relying on the ECB to keep purchasing peripheral bonds until more "permanent" measures can actually be implemented. Credit markets won't sit around and wait for that to happen, even if it is a relatively "big" plan.

"They seemed sorry they hadn't done enough and almost seemed to be asking for forgiveness. "

It's been a good few years since I spent time in Germany/Austria, but- unlike Japan, where children are often taught nothing at all about WWII, in Germany, they do teach it. There's a word for the result: Kollectivshuld; collective guilt.

My impression is that it's still a very active part of the German psyche, with ramifications in all possible directions.

Update from David Gow (yes, The Guardian's "man in Brussels" who reported everything in Europe had been resolved last week and sent markets soaring):

"Some diplomats in this town are in despair - and not just because Brussels is wet, grey and miserable after days of cloudless skies and bright autumnal sunshine. They are now suggesting that the 17 eurozone countries - and, of course, the banks - are so far apart that the draft communique has scarcely moved since last week and is full of gaping holes (with only an annexe on bank recaps ready). "The markets will kill us if they have not already died of laughter," one said.

With ecofin called off as there was no point in having that meeting, some are even wondering why bother with two costly summits. A meeting tonight of the euro working group (top euroland officials led by Signor Grilli) is said to be the last hope of producing a miracle. There is now a slightly more positive suggestion that, assuming the summits sign off politically on a "comprehensive and ambitious deal" (N Sarkozy), the 27/17 finance ministers would have to come back later this week - or even the weekend - to complete the technicalities.

How the markets react to this shenanigans is, well, open to question. Sentiment is not helped by the political impasse in Italy and doubts surrounding the survivability of Berlusconi. At least he appears to be awake now. Apparently, at Sunday's EU-27 meeting, he spent the entire morning asleep...I'm told by "those in the know."

"Anything happening in November is irrelevant right now, since it would be greatly dependent on what actually ends up coming out of Europe this week."

But, it is curious, the situation of the G20 meeting occurring immediately after "this week"! If I was the Eurozone, I think I would play patty cake until that meeting ... all these helpful hands,heh, particularly the US and it's banking exposure to Europe. Who is that who keeps on about how crisis makes a great bedfellow for opportunity?